From Stephen G. Cecchetti and Kermit L. Schoenholtz:
There is certainly room for debate, but we see the question of whether Lehman’s net worth was negligible or sharply negative as ancillary to the real issue. In important ways, lending to a bank of doubtful solvency is little different from lending to one that is certainly so. It will continue to put other institutions, and therefore the system, at risk. In this case, central bank lending to Lehman, an institution widely thought to be bankrupt, would have tarnished everyone else.
Pointer from Mark Thoma. My thoughts:
1. For those of us inclined to agree with this point, an implication is that Citigroup should have been allowed to fail. In fact, the whole bailout policy was misguided. Remember how some banks were forced to take bailout funds even if they did not want them? The idea was exactly to “tarnish everyone else” in order to avoid tarnishing the insolvent banks!
2. Regardless of the merits of letting Lehman fail, one of Ball’s main points still stands. That is, Bernanke and others have been lying by claiming that the decision was based on legal considerations. Ball did not find any evidence that the Fed made a judgment based on such considerations. In fact, it appears that it was not the Fed’s judgment at all, and instead Hank Paulson was calling the shots.
Here are the big questions I do have:
1) What should have happened to Lehmen Brothers? Part of the problem was these ‘Shotgun Marriages’ made both institutions weaker and the number of solvent was limited. I remember BofA was only slightly better than Citibank but they were being dragged down by the Countrywide purchase.
2) Wasn’t one of the loudest ‘banks’ complaining about the money Goldman Sachs? If AIG was allowed to completely fail would have Goldman Sachs become insolvent? Also, does General Electric as well?
3) I rationalized TARP worked like the FDR ‘Bank Holiday’ in which in times of complete financial panic the government made quick and reasonable decisions on which financial would survive. Both were ugly processes in reality but stopped the panic. Citibank was just good enough to survive.
It is always a judgment call where to draw the line. Too early risks moral hazard with ever greater speculative excesses. Too late risks ever greater disasters that become vastly more difficult to stem. Citibank was at least a commercial bank and under direct Fed supervision, which is probably why they didn’t allow any other investment banks to fail, the rest were no worse.
I gather Ball thinks the Fed should have caught the falling knife, even though value is based on future expectations. The interesting thing was Buffet was prepared to catch it but Lehman preferred bankruptcy to his terms.
You keep talking like The Fed is just another firm.
I like it.
Banks aren’t allowed to choose chaotic bankruptcy (or aren’t supposed to be). There are tragedy of the commons and public good considerations to allowing deflationary financial panics to propagate.
And The Fed should not be allowed to cause a panic in order to justify panicked responses.
The Great Depression panic was due to depositors getting wiped out. This was not going to happen if all the Big Banks failed — there was plenty of money for the $250k (5 years of median wage) max insured for each depositor.
Lots and lots of “the rich” would have quickly lost millions, in some cases maybe billions.
But who “on Main Street” would have suffered by not being able to get a loan? Which savers would be unable to save? No savers, none on main street would have suffered much with the loss of the Big Banks, including AIG and even GE.
Total equity wipeout of the irresponsible rich investors in the overpaid irresponsible Big Bankers would have been better for the last 8 years, and the picking up & rearranging of the asset pieces would have generated more new opportunities for new entrepreneurs.
The old guys who were saved were Paulson’s friends. Terrible crony capitalist money to the irresponsible rich.
The problem is that often businesses receive revenue well in excess of $250,000 and then disburse most of the money to employees, suppliers and other creditors. Wiping out such business would have affected main street.
One suggested solution is narrow banking where such accounts are segregated into holding only t-bills and such so they shouldn’t be in question in a financial panic.