A year after Lehman’s collapse

What’s at stake: Coming on the same weekend as the 11th-hour bailout of the giant insurer American International Group, and the sale of Merrill Lynch, Lehman’s failure was the climax of a cataclysmic weekend in the financial industry. On the one-year anniversary of the Lehman Crisis, the biggest names in financial punditry have been voicing their thoughts while policy makers on both sides of the Atlantic used this week’s anniversary to pledge to drive through financial reforms. Next week the stage for regulatory reform moves to Pittsburgh where leaders of the G20 countries will discuss a push for simpler, stronger rules on bank capital, an effort to rein in bankers’ bonuses, and mechanisms to force banks to draw up “living wills” so that they could be dismantled in the event of another collapse.

Niall Ferguson says that Lehman had to die pour encourager les autres. The idea that the world would have been so different if Lehman had been saved is wishful non-thinking. If only Lehman had been bailed out, the story goes, the stock market would not have tanked, the unemployment would not have jumped to new heights, and Michael Jackson would not have needed to commit to those 50 comeback gigs in London. Ferguson argues that a rescue would likely have outraged Congress, hence preventing what was really needed: a huge bail-out across the board in the form of the $700bn troubled asset relief programme (TARP). So, like the executed British admiral in Voltaire’s famous phrase, Lehman had to die pour encourager les autres – to convince the other banks that they needed injections of public capital, and to convince the legislature to approve them.

Martin Wolf warns against learning the wrong lessons from Lehman’s failure. Although letting Lehman go was not our biggest mistake – that was letting the economy and financial system become so vulnerable – it is now clear that every systemically significant institution must be rescued in a crisis. The question remains whether enough will be done to eliminate the present incentives to game the system. The second big potential mistake is to return to the old doctrine that it is better to clean up after a crisis than to take any pre-emptive action. Instead, as argued by William White, formerly chief economist of the Bank for International Settlements, “pre-emptive tightening” should replace “pre-emptive easing” in monetary policy to offset the powerful incentives for credit creation.

The Economist Free Exchange says that it is remarkable that a year after the crisis, explicit authority and clear procedures to wind down complex financial institutions have not been a part of some bill that has made it into law. Whether or not one believes that crisis was inevitable, it is clear that uncertainty over how and whether to handle such institutions complicated the situation last year, added to the panic, and thereby contributed to the real economic cost of the crisis. Meanwhile, the regulatory debate seems to be focusing on the financial product safety commission and the need for a systemic regulator, when the one tool basically everyone agrees was needed still isn’t available.

The World Bank Crisis Talk Blog looks at the current policy discussions and says it is remarkable how little discussions have changed from a year ago. The FT Alphaville Blog has a selection of academic papers and speeches examining the fall of the investment bank.  And Gillian Tett and Nicole Bullock notes that the return to “normality” is still not universal in financial markets.

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