Via Niall Ferguson in the Telegraph.co.uk:
This crisis was not the result of deregulation and market failure. In reality, it was born of a highly distorted financial market, in which excessive concentration, excessive leverage, spurious theories of risk management and, above all, moral hazard in the form of implicit state guarantees, combined to create huge ticking time-bombs on both sides of the Atlantic. The greatest danger we currently face is that the emergency measures adopted to remedy the crisis have made matters even worse.
It has often been said since the crisis began that an institution that is “too big to fail” (TBTF) is too big to exist. I agree. The question is how we can best get rid of the TBTFs without increasing the power of government in the economy still further.
Economists have long held that bank failures pose a “systemic” economic risk, because failed banks are associated with monetary contractions for the economy as a whole. There is therefore a presumption that, if big banks are threatened with liquidity or solvency problems, they should be bailed out by the action of the central bank or government. Despite much pious talk of “moral hazard” prior to 2007, little was done to disabuse big financial institutions of this notion. They could and did assume that they enjoyed an implicit government guarantee.
With the exception of Lehman Brothers, they were right. Beginning with the British Government’s takeover of Northern Rock in 2007 and culminating in the US Government’s vast injections of capital into AIG, Citigroup and other institutions, the Western world has witnessed a succession of government interventions in the banking system unprecedented other than in time of war. These measures can be justified on the ground that without them there would have been a banking crisis comparable with that of 1931, which did as much as the 1929 stock market crash to plunge the world into a Great Depression.
But there is a danger that justified emergency measures give rise to unjustifiable permanent conditions.
Read the full article here
Niall Ferguson writing in the Financial Times:
All would not have been for the best in the best of all possible worlds if only Lehman Brothers had been saved. On the contrary, a decision to bail out Mr Fuld would almost certainly have had worse consequences than letting him and his company go under.
…Lehman’s chief executive persistently over-played his hand, overvaluing the property assets on the bank’s balance sheet by as much as $25bn-30bn. Mr Fuld was adamant: “As long as I am alive this firm will never be sold. And if it is sold after I die, I will reach back from the grave and prevent it.”
…But there was a reason why no buyer could be found in this universe. Lehman was a firm in its death throes. It had lost $6.7bn in the space of six months. It had debts in excess of $600bn. Its assets were collapsing in value. Even when a deal with Barclays seemed within reach, the British Financial Services Authority vetoed it. Alistair Darling, the chancellor of the exchequer, made it clear: “We are not going to import your cancer.”
…Not everything in history is inevitable; contingencies abound. Sometimes it is therefore right to say “if only”. But an imagined rescue of Lehman Brothers is the wrong counterfactual. The right one goes like this. If only Lehman’s failure and the passage of Tarp had been followed – not immediately, but after six months – by a clear statement to the surviving banks that none of them was henceforth too big to fail, then we might actually have learnt something from this crisis.
The real tragedy is that the failure of Lehman has left Wall Street’s survivors both bigger in relative terms and more secure politically. As long as the big banks feel confident that they can count on the government to bail them out – for who would now risk “another Lehman”? – they can more or less ignore calls for lower leverage and saner compensation.
If only we had learnt from Lehman that no bank should be “too big to fail”, we might still have a real capitalist system, instead of the state-guaranteed monstrosity that is the real legacy of last year’s crisis. If only.
Read the full article here
Niall Ferguson: The Ascent of Money: A Financial History of the World
This is a great article by David Cho of the Washington Post. As we Bailout more banks, we are creating more behemoths — reducing consumer choice, and feeding ever more Moral Hazard:
When the credit crisis struck last year, federal regulators pumped tens of billions of dollars into the nation’s leading financial institutions because the banks were so big that officials feared their failure would ruin the entire financial system.
Today, the biggest of those banks are even bigger.
The crisis may be turning out very well for many of the behemoths that dominate U.S. finance. A series of federally arranged mergers safely landed troubled banks on the decks of more stable firms. And it allowed the survivors to emerge from the turmoil with strengthened market positions, giving them even greater control over consumer lending and more potential to profit.
J.P. Morgan Chase, an amalgam of some of Wall Street’s most storied institutions, now holds more than $1 of every $10 on deposit in this country. So does Bank of America, scarred by its acquisition of Merrill Lynch and partly government-owned as a result of the crisis, as does Wells Fargo, the biggest West Coast bank. Those three banks, plus government-rescued and -owned Citigroup, now issue one of every two mortgages and about two of every three credit cards, federal data show.
A year after the near-collapse of the financial system last September, the federal response has redefined how Americans get mortgages, student loans and other kinds of credit and has made a national spectacle of executive pay. But no consequence of the crisis alarms top regulators more than having banks that were already too big to fail grow even larger and more interconnected.
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banks, credit crisis | Graham | 
Tuesday, October 6, 2009 9:01 pm | 
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