Lehman Drives Sword Into Laissez Faire

Daily Telegraph (UK) September 14, 2009

Accessibility links

Digital Publisher of the Year

Monday 14 September 2009 | Roger Bootle feed | All feeds

By Roger Bootle, Columnist Published: 7:46PM BST 13 Sep 2009

Comments 10 | Comment on this article

What is it about September? Before last year, the greatest event in recent British economic history was the exit from the ERM in 1992. It happened on September 16. Before that, the most momentous economic event was leaving the Gold Standard in 1931. When? You guessed it, in September – on the September 21, to be precise. And the fall of Lehman Brothers, which, although it happened in America, ushered in many major consequences here, was announced on September 15 last year.

The Lehman failure marked a pivotal point in our history. It unleashed such panic that for a time it seemed that the whole financial system might implode and the world could be plunged into an economic collapse equal to or greater than the Great Depression. Banks would not lend to each other, asset values plunged and markets became illiquid. People and companies wondered whether any bank was a safe home for their money.

The renewed confidence that we see about us now is largely to be interpreted as a feeling of relief that this Armageddon scenario of a complete banking collapse has been avoided. After the Lehman debacle it was effectively decided on both sides of the Atlantic that no other banks or financial institutions would be allowed to fail. And they haven't.

Before the collapse of Lehman, Bear Stearns, a lesser name than Lehman, had been rescued. Indeed, for all the American rhetoric about the merits of free market capitalism, the Americans have quite a history of bailouts of financial institutions: the virtually unknown hedge fund LTCM was rescued in 1998 (in September, by the way). Fed chairman Alan Greenspan said at the time that if it had been allowed to fail the whole financial system would have been imperilled. Yet if that was true of LTCM why was it not true of Lehman?

In both the US and the UK, the authorities' approach was that where financial institutions could be allowed to fail without the realistic danger of systemic consequences then they should be so allowed. Otherwise, the system would be subject to moral hazard; that is to say, the banks would be encouraged to behave recklessly, confident in the belief that they would be bailed out. The Bank of England had operated this principle successfully in allowing Barings to go under in 1995. But where a failure endangered the whole of the financial system then a bank should be rescued, if necessary using public money.

Although the principle might be clear, there were several problems with the practice. For a start, no one knew exactly where the boundaries would be drawn – and that included the authorities. Moreover, if the moral hazard argument was accepted as a rationale for providing support only for the systemically important institutions, then shouldn't tough action be taken to restrain their activities? It wasn't.

Many people in the markets subscribe to a conspiracy theory about Lehman's fall. They believe that it was all due to the rivalry with Goldman Sachs. The Treasury Secretary, Hank Paulson, whose decision it was whether or not to rescue Lehman, was a former head of Goldman Sachs. He and the head of Lehman, Dick Fuld, supposedly disliked each other. I am deeply suspicious of this view. In general, when faced with the explanation for almost any event I am inclined to subscribe to the cock-up rather than the conspiracy view of history. And there was plenty of scope for cock-ups.

In the Lehman case, most importantly, there was the difficulty of unravelling just what was on the balance sheet. If US taxpayers were to stump up sufficient cash what exactly would they be getting for their hard-earned dollars? No one could say – and that included the senior executives of Lehman itself.

Was it a mistake to let Lehman go? If it had been saved, the exact shape of events would have been different, to be sure. But given that the authorities did not have unlimited funds, the crunch point would have come over some other potential bail-out. All along there has been a considerable body of opinion in the markets and elsewhere, not least in Congress, that failing financial institutions should be allowed to fail. That is how the capitalist system works, they say.

Accordingly, there were always doubts about whether enough money to bail out major banks would be forthcoming. You only have to note the Congressional opposition to the Treasury's TARP programme, even after the Lehman failure, to see that.

There are still people who believe not only that letting Lehman go was the right decision, but also that it would have been right to have let all the rest go also. Yet surely what these events brought home is the unique position of finance in our economy. If the financial system implodes it is the equivalent of switching off the electricity supply. If you did that the economy would eventually recover – but it would return to a pre-electricity state. And heaven help us in the meantime. This realisation has driven a sword through the case for laissez faire. For if banks, or at least big ones, can't be allowed to go bust, then they cannot be allowed to plough their own furrow, maximising their own profits as they see fit. A government that recognises it must stand behind the banking system has a right to a strong view of banks' holdings of capital and liquid assets, its risk taking and its remuneration policies.

The Lehman episode also casts light on the now widely held view that the essential element of a reformed financial system is an enforced separation of commercial and investment banking. I have some sympathy with this view but enforced separation cannot allow the authorities to wash their hands of the investment banks. The striking thing about Lehman was that it was an investment bank. No private individuals' deposits were directly at stake at all. But, because of the inter-linkages within the system, in practice all individuals' deposits were indirectly at stake.

The events which followed the collapse of Lehman also transformed the fiscal landscape. For if banks cannot be allowed to go bust, then the government which gives this guarantee must be in a sufficiently strong financial position for it to be credible. That means not being saddled with huge debts to start with. Even medium-sized countries like the UK have to think twice before encouraging the development of huge financial sectors that challenge the ability of their government to bail them out. For these reasons, although the Lehman business has passed away, the Lehman name will live on in history.

Comments: 10

http://www.nytimes.com/2008/07/01/opinion/01brooks.html?_r=1&ref=opinion&oref=slogin "Men are neither rational nor instinctually good. Government, therefore, invariably tends toward corruption and despotism." Martin Malia, famed historian

Musing on this, I think I do see where RB is coming from. When he speaks of 'the sword through the case...' he simply means that laisser-faire would not suffice to clean up the mess. Well naturally! I agree! If children are encouraged to play with matches on their own, it may well be necessary later to utterly ruin their home by deluging it with water and foam to try to prevent the other half of the roof falling in. By that point, there really is no alternative. But it might have been better to avoid that drastic solution - by creating circumstances which instill a lively sense of responsibility, ownership and danger. The situation which arose was not inevitable but created. But we are going to learn all the wrong lessons (and Hayek will not be read for a generation. Indeed I expect it will be taught that it was all his fault!)

No sword has been driven through the case for laisser-faire. Roger Bootle starts from the wrong point in time. Laisser-faire did not exist. Had it existed, his 'unique position of finance in our economy' as he delicately describes what had been going on in the cosy relationship between politicians, central bankers, investment bankers, rating agencies and the rest, would not have existed. There is nothing quite like laisser-faire to concentrate the mind when it comes to risk-taking! Under laisser-faire, Bootle's electricity-supplying power plant would have been robustly built. Surely that is the whole point. There would have been no question of 'returning to a pre-electricity state. And heaven help us in the meantime'. The danger of the so-called nuclear winter, soup-kitchens and the rest was rather precisely due to the massive risk-taking that arose from the lack of laisser-faire. (I suppose it is possible that Fred Goodwin would have bought ABN Amro if RBS had been a bank belonging to himself and his family but I doubt it.) It is difficult not to infer from Roger Bootle's comments that he rather admired the house of cards which politicians, eager for tax revenue, connived and incentivised to be built, precarious card on precarious card, over so long! I liked an article some time ago by Nassim Nicholas Taleb in the FT, 'Ten principles for a Black Swan-proof world'. These included: 'What is fragile should break early while it is still small. No socialisation of losses and privatisation of gains. People who were driving a school bus blindfolded and crashed it should never be given a new bus. Do not let someone making an incentive bonus manage a nuclear plant. Conterbalance complexity with simplicity. Do not give children sticks of dynamite, even with a warning. Do not give an addict more drugs if he has withdrawal pains.'

On the contrary, "letting [LB] go", makes the case for laissez-faire capitalism, rather than driving a sword through it. LB losses have not been socialised, moral hazard has been preserved and a consequentially weakened banking system has been taught there are limits. The price of TARP and other interventions is the line in the sand. There is only so much government money to go around. Private capital will takes it's place in time, appetite for risk will return, but please Mr Bootle, can we really afford to fence off every opportunity, simply because we cannot anticipate or measure the risks?

As reported today in the telegraph Robert Stiglitz says the banks are in worse shape than they were in 07.I know he is just another expert but I believe it. Sarkozy is to be briefed by this respected man in anticipation of an important gathering of our peers. As AEP reports the Germans are in a state of panic. I suggest a big credit crunch shall inevitably come to Europe. If September sees a horrible correction to the (bear market rally?)markets followed by new systemic risk for Europe's banks, it might not be possible to talk up the sentiment essential for the survival of this ghastly ponzi fractional reserve fiat money scam that makes fools of our peoples.

"Laissez faire" has never existed we have the central banking model and an econonmy completly regulated by the bankers, government and quangos. I do not see how people can write this stuff with laughing. Read Hayek and Austrian school for an education in laissez faire and how and why we do not have it with our current monetary system and socialist business planning. Its all quite clear and I am sure even a telegraph hack could understand it. Its funny how it is so important that the money printers never be allowed to fail, never be allowed to miss a bonus, must always have more power, must always be allowed to further regulate themselves, must always be able to secure more debt on the heads of the people, must always be allowed to have bigger and bigger banks with more and more proctection for themselves(another name for regulation) etc. When the fact is, they print money and issue it as debt, the debt enters the economy as inflation, gives false signals causing investment that cannot be sustained without further and further borrowing, which means when the borrowing stops the production structure collapses. Government tries to fill the vacume by borrowing more and more until the whole thing comes crashing down in a wave of nationalisation and unemployment where the people demand more power to the government which will guarantee them a more miserable future (why? Because governments cannot calculate read "Economic Calculation In The Socialist Commonwealth"). If you really want the banks regulated bring back the gold standard, not just "we will boost capital requirements" or we will back our money printing with SDRs printed by the IMF which is controlled and chaired by the same bankers wanting more power. Hopefully people are waking up and the money printers will have their day and have to go out and get real jobs. It really isnt very difficult to become rich and powerful if you are allowed to legally counterfeit money.

They should never have bailed out LTCM - or cut base rates to support the market in 1987 and 2001 - or allowed any bank or financial institution to become so big. They should never have used Fannie Mae and Mac to extended liar loans to people who could not pay. They should never, ever have messed with the price of money - because that is messing with the price of risk - and when that happens you get a gross mis-allocation of resources that leads to asset price bubbles. We need more risk in the system not less. We need floating currencies and interest rates. We need to get away from this socialist idea that the state can prevent busts yet deliver perpetual booms. We need more volatility to keep the market on its toes - rather than lulling people into a false sense of security that leaves them shocked when the inevitable crisis hits. (Better rolling hills than easy fields followed by jagged mountains - better a little danger every day than a lot once in a lifetime.) Banks need to be smaller and leaner. Markets need to be more transparent and efficient - that means less government interference not more. Blessings for an end to moderation and meddling. Father Ignatius Brown www.father-ignatius-brown.com

It is quite annoying that commentators write about the current crisis as it was an economic crisis. In fact it is a result of common criminality called "pyramid scheme". It is not capitalism or free market that failed. We were robbed by financial gangsters. For READ: http://gregpytel.blogspot.com/

We never had laissez faire. We had central banks, we had fiat money and we had state deposit insurance. Roger Bootle should be ashamed of himself for writing such blatant drivel.

I am an avid supporter of free market economies and economics. we will never know what would have happened if LB was bailed out. The results of the fall out has been an almight shock to the banking and real world economies. This rough ride (and its not over yet) has the opportunity of transforming a runaway train into a system of effective control points and stops along the way to maximise the opportunity to reflect on what is really going on and ensuring the checks and balances are in working order. the only gray cloud to prevent this opportunity being effective is the ineffectiveness of governments and regulators to ensure the points and stops are consistent and enforced at the same time with the same disciplines. it worries me that key players who waved the runaway through are now by and large the one and the same. i COULD go on and on...

Lehman Drives Sword Into Laissez Faire

Related Articles