A Lehman Restitution Fund

Imagine how employees and shareholders of Lehman Brothers feel heading home this weekend. Their firm filed for bankruptcy on Monday, costing them jobs and sacrificing their net worth. This weekend, Congress will write legislation authorizing government to buy hundreds of billions of dollars of troubled assets from many other firms that will thus escape that fate. If this result seems unfair, arbitrary or induced by representations made to Lehman by the Fed and Treasury, should Congress make provision to balance out this result by creating some form of restitution?

Last weekend, the Federal Reserve and the US Treasury reportedly stated or signaled to Lehman’s leadership that no federal assistance would be forthcoming for it or other firms bearing the burden of troubled assets clogging the credit markets. Lehman filed for bankruptcy at least in part on the strength of those communications. Similar signals or statements partially explain Merrill Lynch’s decision to agree to a takeover by Bank of America.

Those authorities reversed course the next day when selectively extending financial support to American Insurance Group. Today, those authorities, now finally coordinating with Congress, indicate a planned wholesale intervention to remove essentially all such troubled assets from essentially all firms. If that decision were taken last week instead of this week, or if Lehman and Merrill had chosen to sit tight this week, the government repurchase would have included troubled assets held by those firms as they existed. Employees and shareholders of those firms would be in a much better position today, one functionally equivalent to peers at other firms facing substantially similar problems.

A consensus appears that the case-by-case nature of the Fed and Treasury approach this week, and earlier, was arbitrary. To the extent that the Fed or Treasury made statements to Lehman, or Merrill, on which the latter relied to their detriment, a reasonable case arises that some form of restitution may be warranted.

True, Congress cannot correct all mistakes that the Fed and Treasury made or address every inequity that their potentially unprincipled decision-making process created. And certainly factors other than Fed or Treasury statements or signals likely influenced Lehman’s, and Merrill’s, decisions. Perhaps the fate of those firms and their employees and shareholders should simply be chalked up to the workings of capitalism and attendant labor and equity markets.

But if the Fed and Treasury, unelected and only remotely accountable officials, are culpable in any way, Congress, elected and accountable representatives, may wish at least to consider whether some form of restitution may be justified. Given the huge size of the troubled asset purchases that Congress is poised to authorize, a restitution fund to compensate Lehman (and Merrill) employees and shareholders would be a relatively small proportion of the total.

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2 Responses

  1. Mike Guttentag says:

    Really? The government creates liability as it muddles through because it fails to realize the unintended consequences of letting Lehman fail. (Moreover, is an investment banker ever reasonably ever entitled to job protection, much less federally funded?)

    The problem you raise may be similar to the one created when the government bailed out the Bear Stearns debt holders, while trying to give the Bear Stearns equity holders virtually nothing, but count me as very cynical of the claim in this context.

  2. Miriam Baer says:

    Wouldn’t portfolio diversification be a partial answer to this problem, at least with regard to the shareholders? If you have a diversified portfolio, you might have lost money on Lehman at the beginning of this week, but (maybe) you made it back as a result of the government’s bailout at the end of the week.

    Of course, there is no such comfort if you are a (former) employee of one of these firms since you can’t diversify your labor. Nevertheless, I can’t imagine any political support for an employee “restitution fund” at this point.