Lehman failure spurs recovery efforts

By DAVID NICKLAUS

The second-guessing started almost as soon as Lehman Brothers, a 158-year-old Wall Street institution, made its early-Monday-morning trip to bankruptcy court.

Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke were accused of acting recklessly when they decided to let Lehman fail. Critics said they needlessly panicked world financial markets because of their principled opposition to yet another bailout.

A year after Lehman’s collapse, the criticism continues. The refusal to bail out one firm, as it turns out, generated a need to prop up dozens of others, from American International Group to General Motors to the entire money market fund industry. The post-Lehman panic shook the very foundations of capitalism.

Could the turmoil have been avoided? Should the government have shoveled tens of billions of dollars into the struggling financial titan, as it had done with Bear Stearns and would do with AIG, Citigroup and others?

Certainly a rescue would have been politically unpopular. Voters, in an election year, were angry about the March 2008 bailout of Bear Stearns. The collapse of mortgage giants Fannie Mae and Freddie Mac, one week before Lehman, added to the sense that our financial system was rotten to the core.

Moral hazard was the catchphrase of the day. If bankers could count on a bailout, they would take too much risk with shareholders’ and depositors’ money. You could get a big bonus if your risky bets paid off, and hand taxpayers the tab if they didn’t.

Each bailout produced more moral hazard; letting a big bank fail would, in theory, bring back market discipline.

Instead, it brought market chaos.

“Letting Lehman go cost us enormously,” says Diane Swonk, chief economist at Mesirow Financial in Chicago. “The political will for bailouts was gone after Fannie and Freddie. I think Bernanke would have liked to save Lehman, but the reality was he couldn’t.”

Inconsistent decisions

Scott Colbert, director of fixed-income investing at Commerce Trust Co., doesn’t fault the authorities for letting Lehman fail, but he does fault them for making a series of arbitrary, inconsistent decisions. After the Bear Stearns, Fannie Mae and Lehman episodes, creditors couldn’t be sure where they stood with any big bank. That uncertainty, Colbert says, made the credit crunch worse.

No one can say, of course, whether a Lehman bailout would have averted the panic. The market might have just shifted its focus to other shaky companies, such as AIG and Citigroup, leading to a succession of weekly crises with no clear endgame.

The Merrill Lynch saga should also be a cautionary tale for bailout proponents. On the same weekend that Lehman failed, Merrill was pushed into a merger with Bank of America. When Merrill’s losses proved to be bigger than expected, B of A itself looked shaky for a time. Eventually, the bank bolstered its capital with $45 billion from the Treasury’s troubled asset relief program.

If Merrill’s problems were enough to push B of A to the brink of disaster, was any bank strong enough to take on Lehman? In essence, a decision to keep Lehman alive would have amounted to kicking the financial system’s problems down the road. We would have had to face them eventually, and time wasn’t going to make them any less expensive.

As it was, Lehman’s failure triggered the worst financial panic since 1929, but it also forced the Fed, Treasury and Congress to take measures that eventually will lead to recovery. The process was painful but, all second-guessing aside, it also was necessary.

X David Nicklaus is a columnist for the St. Louis Post-Dispatch. Distributed by McClatchy-Tribune Information Services.