Word: lehman
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...already knew all this, of course. It happened just last year, and in recent weeks, the news media have engaged in an orgy of commemoration and explanation of the Lehman collapse and its aftermath. So here's the $64 trillion question: What, if anything, have we learned...
First, the fragility, a.k.a. risk. A year ago, officials at the Treasury Department and the Federal Reserve didn't think letting Lehman go bankrupt would be a disaster. Those same officials have since argued that the law gave them no choice. But it's also clear that the authorities--then Treasury Secretary Hank Paulson, in particular--didn't want to intervene. The Fed and Treasury had taken a lot of flak for their earlier bailouts of Bear Stearns, Fannie Mae and Freddie Mac. It was time to let the market work...
Within days of Lehman's failure, it was apparent that the market wasn't up to the task. There was a run on money-market funds after the Reserve Fund (which had pioneered the money-fund business in 1970) revealed that it owned a lot of suddenly worthless Lehman debt. London-based hedge funds that relied on Lehman for day-to-day financing found themselves unable to do business. Similar dislocations played out around the world, and financial institutions became paralyzed by fear and confusion. They simply didn't trust one another anymore and didn't want to lend...
...Great Depression, powerful voices at Treasury and the Fed argued that financial crisis was a necessary corrective. "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate," Treasury Secretary Andrew Mellon advised President Herbert Hoover. "It will purge the rottenness out of the system." This time around, after Lehman went under, no one at Treasury or the Fed talked that way. Instead, policymakers in the U.S. and overseas agreed that the panic had to be stopped at any cost. And it was, through a bailout that placed trillions of taxpayer dollars at risk. It was expensive, messy and unfair...
...leading to complacency. Consider the financial reforms that Obama's Administration wants to push through Congress: the big ones are creating a Consumer Financial Protection Agency, giving the Federal Reserve the job of systemic-risk regulator and establishing a "resolution regime" to wind down troubled nonbank financial institutions (like Lehman) and complex bank holding companies. Steps in the right direction? Probably. Truly major reforms? Not so much--and even they may not win congressional approval...