On the heels of this post from a couple of days ago that addressed Tyler Cowen’s recent NY Times op-ed that speculated that expectations generated from the 1998 government bailout of Long Term Capital Management hedge fund were not such a good thing, this W$J article on the Lehman Brothers bankruptcy case bemoans the enormous cost attributable to lack of reorganization planning in connection with the Lehman Brothers case:

As much as $75 billion of Lehman Brothers Holdings Inc. value was destroyed by the unplanned and chaotic form of the firm’s bankruptcy filing in September, according to an internal analysis by the company’s restructuring advisers.

A less-hurried Chapter 11 bankruptcy filing likely would have preserved tens of billions of dollars of value, according to a three-month study by the advisory firm, Alvarez & Marsal. An orderly filing would have enabled Lehman to sell some assets outside of federal bankruptcy-court protection, and would have given it time to try to unwind its derivatives portfolio in a way that might have preserved value, the study says. [.  .  .]

"While I have no position on whether or not the federal government should have provided further assistance to Lehman, once the decision was made not to provide further assistance, an orderly wind-down plan should have been pursued. It was an unconscionable waste of value," said Bryan Marsal, co-chief executive of the advisory firm who now serves as Lehman’s chief restructuring officer.

Mr. Marsal estimates that the total value destruction at Lehman will reach between $50 billion and $75 billion, once losses from derivatives trades and asset impairment are combined.

Losses are a natural part of the risk allocation that occurs in big reorganization cases. But anyone who has been involved in such cases knows that it takes at least a couple of months to prepare a big reorganization case properly.

Friends who are closely involved in the Lehman Brothers case have confided to me that Lehman CEO Richard Fuld never in his wildest imagination thought, after the precedent of Bear Stearns, that the Fed and the U.S. Treasury would fail to bail out Lehman Brothers. When that proved wrong, Lehman Brothers had to file its chapter 11 case on a relatively unplanned, emergency basis. That miscalculation cost creditors even more than they would have lost had Lehman’s management taken the normal step of planning the case when they saw the writing on the wall. I’ve got my doubts that the additional losses are $50-75 billion as suggested by the consultant’s report (could the Lehman-related parties be using that report as a liability shield?), but there is little question that an emergency bankruptcy filing generally costs creditors more than a properly planned one.

As John Carney notes, maybe the conventional wisdom is wrong that the Fed made matters worse by failing to bailout Lehman Brothers.

It’s hard enough to evaluate the risk of insolvency in regard to a trust-based business under normal circumstances. It becomes a real crapshoot when there exists an expectation that the federal government will provide stop-gap financing for a big trust-based company’s losses. And crapshoots generate some pretty bad risk-taking.

It really isn’t rocket science.

Marginal Revolution’s Tyler Cowen makes a similar point in this NY Times op-ed about the 1998 federal bailout of the Long-Term Capital Management hedge fund that this earlier post made about Enron and the current Treasury bailout:

At the time, it may have seemed that regulators did the right thing [in bailing out LTM]. The bailout did not require upfront money from the government, and the world avoided an even bigger financial crisis.

Today, however, that ad hoc intervention by the government no longer looks so wise.

With the Long-Term Capital bailout as a precedent, creditors came to believe that their loans to unsound financial institutions would be made good by the Fed — as long as the collapse of those institutions would threaten the global credit system. Bolstered by this sense of security, bad loans mushroomed. [ .  .  .]

The major creditors of the fund included Bear Stearns, Merrill Lynch and Lehman Brothers, all of which went on to lend and invest recklessly and, to one degree or another, pay the consequences. But 1998 should have been the time to send a credible warning that bad loans to over-leveraged institutions would mean losses, and that neither the Fed nor the Treasury would make these losses good.

Absent allocation of risk consequences to the parties who entered into transactions with financially-troubled companies, markets have a difficult time accurately pricing risk in regard to future investment and transactions. Such indecision plays a big part in delaying recovery in financial markets.

Similarly, without cleaning up the balance sheets of troubled companies (and putting the hopelessly insolvent ones out of their misery), extending additional credit to financially-strapped companies only makes them an even poorer risk for investment. That doesn’t facilitate recovery in the financial markets, either.

Amidst many blunders, the Bush Administration’s failure to tap corporate reorganization experts in connection with its policy-making regarding the financial crisis was one of the worst. Hopefully, Obama’s advisors note the mistake and correct it in the next Administration.

Update: Barry Ritholtz agrees with Tyler and me.