Missing Lehman Lesson of Shakeout Means Too Big Banks May Fail
Bloomberg has a great (long) piece on missing the lessons of last year’s financial collapse. Below is an excerpt from the article:
Of all the quakes of 2008 — the fall of Bear Stearns Cos. in March, the takeover of mortgage buyers Fannie Mae and Freddie Mac and the salvaging of American International Group Inc. in September — the failure to account for the effects of Lehman’s demise was the most critical because its aftershocks came closest to wrecking the world economy.
“They put the entire financial system at risk, and they didn’t have to,” said Harvey R. Miller, a partner at Weil Gotshal & Manges LLP in New York who represented Lehman in the bankruptcy, referring to government officials. “They were warned. I told them, ‘Armageddon is coming. You don’t know what the consequences will be.’ Their response was, ‘We have it covered.’”
Paulson and Geithner, who succeeded him as Treasury secretary, both declined to comment.
Inviting ‘Catastrophe’
One year later, policymakers haven’t learned the lesson of the bankruptcy, said Richard Bernstein, CEO of Richard Bernstein Capital Management LLC in New York and former chief investment strategist for Merrill Lynch.
Rather than break up institutions such as Bank of America Corp. and Citigroup Inc., or limit their expansion, the U.S. has given them billions of dollars in tax incentives and loan guarantees that enabled them to grow even bigger. To protect against a bank collapse touching off another freefall, President Barack Obama has proposed regulatory changes that rely on the wisdom of bankers and government overseers — the same people who created the conditions that led to Lehman’s bankruptcy and were unable to foresee its consequences.
“Designating certain institutions as too big to fail, and not having a thorough regulatory process to match, practically invites another catastrophe,” Bernstein said.
Rescue efforts exposed a financial system with so many moving parts that U.S. regulators and the world’s top bankers couldn’t keep track of them all. A reconstruction of the meetings at the New York Fed that preceded Lehman’s bankruptcy, drawn from more than a dozen interviews with participants, reveals a failure to understand the importance of commercial paper and how that market would be affected by the collapse of the New York investment bank.
Ice-Nine
It turned out to be a $3.6 trillion blind spot.
Like the fictitious substance ice-nine in Kurt Vonnegut Jr.’s 1963 novel “Cat’s Cradle,” a seed of which set off a chain reaction that transformed all the world’s water into ice, Lehman’s failure froze credit markets, said Simon H. Johnson, a former chief economist at the International Monetary Fund.
“Ice-nine was invented by a crackpot scientist, and it was unleashed by mistake,” said Johnson, now a professor of finance at the Massachusetts Institute of Technology’s Sloan School of Management in Cambridge. “How did the financial system get so fragile that this could happen? What were the guys overseeing it doing?”
The bankers and regulators who met at the New York Fed unwittingly dropped the first seed.
Great stuff. You can read the whole article here.
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