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Five years ago this week, Wall Street and Washington were engaged in a desperate attempt to avoid financial catastrophe. Lehman Brothers, the fourth-largest bank on Wall Street, a 158-year-old institution with global reach was in trouble. It was about to collapse under the weight of subprime, mortgage-backed securities tied to the crumbling U.S. housing market.
NPR's John Ydstie has the story on the last days of Lehman and the chaos that followed.
JOHN YDSTIE, BYLINE: Wall Street was already well aware of its dire situation by September of 2008. Just six months earlier, the government had brokered a takeover of the battered investment bank Bear Stearns with $30 billion in financial backing from the U.S. government.
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UNIDENTIFIED WOMAN #1: The rescue of Bear Stearns dominating the entire trading day on Wall Street leading...
YDSTIE: Bear, too, had been done in by bad housing assets. Then, just a week before the Lehman meltdown, the government took over mortgage giants Fannie Mae and Freddie Mac. They were also being crushed by falling real estate prices. Many on Wall Street thought Lehman would be next.
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UNIDENTIFIED WOMAN #2: This week alone, Lehman Brothers' stock plummeted almost 80 percent...
YDSTIE: With concern mounting that a Lehman meltdown could destabilize the global financial system, the task of managing the crisis fell to three men: Fed chairman Ben Bernanke, the president of the New York Fed Timothy Geithner and the U.S. Treasury Secretary Henry Paulson - a former Wall Street banker.
HENRY PAULSON: Oh, you know, I still get the knots in my stomach. I get chills.
YDSTIE: Paulson was the point man in the effort. He was determined not to have another Bear Stearns-style rescue involving billions of dollars in taxpayer funds. With his cellphone glued to his ear, Paulson had been trying for weeks to match Lehman with a private buyer - Warren Buffett was approached, Bank of America too, and finally the British bank Barclays.
PAULSON: For the most part, I was too busy to be afraid. You know, I was playing offense all of the time. The moments of fear usually came in the middle of the night when I would wake up.
YDSTIE: But potential buyers were balking. They didn't want to be stuck with the billions of dollars in toxic assets on Lehman's books. Time is running out. So late Friday afternoon on September 12, Paulson, who was still determined to avoid a federal bailout, called the CEOs of Wall Street's biggest banks to a meeting at the New York Fed.
John Thain, then chairman of Merrill Lynch, described it in a "Frontline" documentary.
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JOHN THAIN: I got a phone call about five o'clock saying be at the Fed at six o'clock that evening. I went by myself. And for the most part, the CEOs of the large investment banks and commercial banks were all there by themselves. They'd said to us we collectively had to find a solution for this. And this is the important part: the government was not going to provide any form of assistance.
YDSTIE: Paulson wanted the bankers to buy some of Lehman's subprime assets to make Lehman more attractive to Barclays but the deal fell apart. At the last minute, British regulators blocked the sale and Lehman's board of directors voted to declare bankruptcy. Paulson was crushed.
PAULSON: The Sunday when Lehman announced bankruptcy, I realized we were at the end of the line. There was not anything else we could do that was legally possible. I knew it was going to be bad, and I had a real knot. Everyone was looking to me in terms of what to say and what to do.
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UNIDENTIFIED WOMAN #3: The Dow is expected to open down 300 points this morning, Robin. So that gives you an indication of how jittery the markets are...
YDSTIE: But as Monday morning broke, there was some support coming to Paulson from editorial pages and Capitol Hill for refusing to bailout another investment bank. With the Dow down just a couple of hundred points, Paulson seemed upbeat as he appeared before reporters in Washington.
PAULSON: Good afternoon, everyone. And I hope you all had an enjoyable weekend.
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PAULSON: Yeah. Yeah. Well, as you know, we're working through a difficult period in our financial markets right now, as we work off some of the past excesses. But the American people can remain confident in the soundness and the resilience of our financial system.
MOHAMED EL-ERIAN: Initially, the market did OK.
YDSTIE: That's Mohamed El-Erian, CEO of the giant bond fund PIMCO based in California. He and his staff had spent the weekend at work among discarded pizza boxes, preparing for the worst, but expecting Lehman to be rescued like Bear Stearns had been six months earlier.
EL-ERIAN: The initial spin and the initial sort of movement was, oh, there must be a plan, because no one in their right mind would allow Lehman to fail in a disorderly fashion. But within hours, it became clear that there was no plan.
YDSTIE: At the end of the day, the Dow closed down 500 points. Former Fed vice chairman Alan Blinder, now a professor at Princeton, says the market was totally confused and nothing seemed safe anymore.
ALAN BLINDER: It looked like the old rulebook that had governed under Bear Stearns had been tossed out the window, and nobody on Wall Street or in the financial markets around the world knew any longer what the rulebook said. And that's a recipe for catastrophe, which would have been avoided had Lehman been treated more or less the same way as Bear Stearns.
YDSTIE: Then, the very next day, the rulebook changed again. The government bailed out the mammoth insurance firm AIG, which had provided insurance in the form of credit default swaps to virtually every big bank in the world, guaranteeing them payment if their bets went bad. That same day, credit began to freeze up. A huge money market fund that held lots of Lehman paper, the reserved primary fund, broke the buck. Its share price fell below $1, the kiss of death for a money fund.
A run-on money market funds began and El-Erian called his wife from the office and told her to go to the ATM.
EL-ERIAN: And take the maximum $500 that you can take. And she said, you know, why? We don't need $500, right? And I said, just go to the ATM. I'm not sure the banks are going to open tomorrow. And she said to me, you must be kidding. I said no.
YDSTIE: What El-Erian saw happening was a failure of trust in the credit system: U.S. companies that needed short-term loans to make payroll and pay dividends couldn't get them. The CEO of General Electric called Secretary Paulson, saying even GE couldn't get loans.
PAULSON: I could quickly see this just snowballing through Main Street and corporate America, and there would be all sorts of failures and job losses. So we were on the edge of an abyss and, without action, we could very easily have had a situation where unemployment levels got to the kinds of levels we saw during the Great Depression.
YDSTIE: Paulson and Bernanke went to Capitol Hill for an emergency meeting with congressional leaders. They told the lawmakers that the U.S. and the world faced another Great Depression, and they needed $700 billion fast to get credit flowing again. A reluctant Congress voted down the request once, and the stock market fell almost 800 points. The next week, the $700 billion TARP fund was approved. But the country still experienced a deep recession. Unemployment reached 10 percent.
Blinder, whose book "After the Music Stopped" details the causes and effects of the financial crisis, says he believes the Lehman collapse triggered the Great Recession.
BLINDER: We got a test case of the argument that had been going on between one side that said: You better save Lehman or all hell will break loose, and another side saying, you know, bankruptcy is part of business and you just let them go. Well, we found out the answer.
YDSTIE: Paulson, Geithner and Bernanke all insist they didn't have the authority to do more for Lehman. But five years later, with growth still too slow, credit still tight and unemployment high, Americans and people across the globe are still suffering. John Ydstie, NPR News, Washington.
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