This kind of observation is becoming popular:
Almost everyone I’ve ever spoken to in Hank Paulson’s old Treasury
Department agrees that without the immediate panic caused by the Lehman
default, the government would never have agreed to make the loans
needed to save A.I.G., a company it knew very little about. In effect,
the Lehman bankruptcy caused the government to panic, which in turn
caused it to save the firm it really had to save to prevent
catastrophe. In retrospect, if you had to choose one firm to throw
under the bus to save everyone else, you would choose Lehman.
Here is much more, by Joe Nocera.
But what to make then of Stanford’s John Taylor thesis that the turmoil followed paulson’s own paniced remarks.
What freaked people out was that the government did not bail them out as everyone expected them too.
Let them fail.
The whole discussion raises an interesting threshold problem: given that the entire financial sector was in a massively overleveraged condition that rested on assets whose value was liable to sudden (and probably, ultimately unavoidable) writedown, when is the right moment for the deleveraging and write-down to happen? (That such overleveraging on the basis of dubious assets might have been prevented in advance by better regulation is a separate issue worthy of serious debate, but not here).
One might argue, ‘the sooner the better’, and say that Bear Stearns should have been allowed to dangle and fall, rather than having Wall Street and the government cooperate in ‘saving’ it. Or, as a poster above suggests, one of the GSEs could have been liquidated — although here, the entanglement with government guarantees and the sheer exposure means that a bankruptcy would probably have resulted in the government taking back all the bonds, so the deleveraging effect would have been muted.
The next opportunity that circumstance offered was Lehman, at least in the US (England got into bailouts earlier with RBS, as I recall). Was this the ‘optimal’ moment — politically as well as fiscally, by causing enough political shift as well as allowing the entire payments system to be saved? (Those who argue that not only Lehman, but the entire international payments system, should have been allowed to crash and burn may be true to their principles, but the ultimately political framework of the economy made such an outcome both undesirable and unlikely).
Or, Lehman could have been bailed out, and then Merrill?
The longer the wait, the more expensive the bailout and more traumatic the side-effects, but also the more effective the triggering of deleveraging. The shorter the wait, the less expensive and traumatic, but also less effective in initiating a deleveraging.
Since deleveraging was ultimately inevitable, the question of when the trigger was ‘optimal’ seems, to me, to be an ultimately political question of competing goods and harms that rests on assessments of ‘what is valuable’, and therefore external to any purely economic analysis.
I think Quincy’s point was correct: if you had to deleverage, Lehman was the point to start to signal your intentions. Although there was collateral damage, there was less than would have been under any alternative scenario of either wait, save the next, and then the next. Sort of like the centipede problem in game theory.
Nor could the government be credible without having someone die…how do you get others to reform their ways, or take your money so they have adequate capital, without an actual failure. Do you think that Wells Fargo would submit to soft cajolling to raise capital, or would it be more likely to respond the the prospect of the grim reaper at the doorstep? Fear is power to the person who can offer relief to get you out of your problem. So, Treasury got more power and voice in the deleveraging of the financial market.
I caught part of a BBC story reviewing the Lehman story in UK that sounded like the UK assets required an injection of 100 million (pounds/dollars from the Royal Bank?) the week of the Monday filing just to cover the expenses of that week.
Can anyone provide some data on how expensive the Lehman bankruptcy is just to go bankrupt and liquidate – the costs after the losses are set by the filing? If it costs hundreds of millions in cash injections to liquidate a firm with negative balance sheet, its it too big to fail, and thus too big to be allowed to exist?
I’m not sure it really happened that way.
The turning-point significance of Lehman wasn’t recognized for a few days. It wasn’t until a large money market fund broke the buck (as a direct consequence of Lehman) that panic started to cascade. The panic trigger was not the bankruptcy itself, but a hitherto overlooked unintended consequence rearing its ugly head. Like hurricane Katrina, a few people probably even breathed a brief sigh of relief in the immediate aftermath before becoming aware that the levees had in fact been breached.
Conversely, in the days immediately before Lehman definitively blew up many commentators and bloggers were already saying that AIG was going to be a much bigger deal than Lehman, with far more wide-ranging repercussions, and that unlike Lehman some kind of government intervention was therefore unavoidable.
My memory, of course, may be faulty. But my impression has always been that bailing out AIG was decided in principle before Lehman was even fully dead.
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