The shame of 9/15/2008

Our apologies. These pieces were penned in the heat of a terrible moment, about which we’ll say now, that it was government idiocy on the level that created the Great Depression, to let Lehman Brothers fail without a strong and stable purchaser.

First, Lehman I: So much for inflation. The underlying trend in many major asset categories has been deflationary for a while, fundamentally on account of ever-restricting credit standards in the marketplace. This has been masked by the speculative bubble in commodities, which would appear to be over. If it isn’t over yet, the (necessary but sad) Chapter 11 filing of Lehman Brothers, the shotgun wedding of Merrill and BofA, and the meltdown of AIG, are all moving us further and further down that path. Oil is now off $50 from its high, and in our view may well have the better part of another $50 yet to fall. WSJ:

Light, sweet crude for October delivery was recently down $5.40, or 5.3%, at $95.78 a barrel on the New York Mercantile Exchange. October Brent crude on the ICE Futures exchange, which expires Monday, was down $5.24 to $92.34 a barrel. Nymex crude earlier fell to $94.13 a barrel, the lowest price since Feb. 14

Meanwhile, China is trying to address future anemic growth through easing lending restrictions, which as we have said many times, probably won’t be enough to keep growth where it needs to be in that country.

Then an update: Oops, the day got a little worse. WSJ:

The Dow Jones Industrial Average, which languished with a loss between 200 and 300 points for most of the day, saw its losses accelerate in the last hour of trading. It ended down by 504.48 points, off 4.4%, at 10917.51. All 30 of its components fell, led by a 60.8% plunge in American International Group. The Federal Reserve on Monday asked Goldman Sachs Group and J.P. Morgan Chase to help make $70-$75 billion in loans available to the company, according to people familiar with the situation…

Bank of America was also a big decliner among Dow stocks, off 21.3%…Goldman was off 12.1%, while Morgan Stanley fell 13.5%…Washington Mutual tumbled 26.7% as investors feared it wouldn’t be able to find a buyer…”We’ve re-established ‘moral hazard,'” a person involved in the Lehman talks told the Journal…”Is that a good thing or a bad thing? We’re about to find out.”

One hopes that, in allowing the failure of Lehman Brothers and the stampede that followed, the current crop of regulators is steering a course to avoid some of the really devastating mistakes of the past.

And a month later, considering the 9/15 folly:

And after The bankers seem to have made the same mistake twice, and it nearly brought the system down again. The Fed Chairman who is a student of the Depression and the Treasury chief who was CEO of Wall Street’s perhaps most storied name, appear to have repeated one of the critical mistakes in judgment that brought about the Great Depression — and they have been scrambling to recover from this mistake for a month. In 1930 the Fed let the Bank of United States fail, the dominoes fell, and the Great Depression was born. On September 15, 2008 the Fed let Lehman Brothers fail, and once again the US is courting financial catastrophe.

One month ago, the Fed and the Treasury let Lehman Brothers go bankrupt, and all hell broke loose, not just because of mortgages, but because of Lehman’s systemically toxic CDS’s — unregulated insurance policies without reserves with other banks — that could bring down the entire industry. This is also the view of the French finance minister. Telegraph:

Mrs Lagarde — attributed with playing a key role in brokering a bailout deal among G7 finance ministers in Washington last weekend — dubbed Mr Paulson’s decision to let the bank go under “horrendous” as it triggered panic in markets and banks to the brink of a 1929-style financial meltdown.

The entire banking system seized up; the banks were set up like dominoes to sequentially fail. Short sellers had a no risk strategy to bet on bank failures and the Treasury had created a Doomsday Machine that would take them down, one after another. Credit and stock markets crashed, and good news had become irrelevant.

In effect, the US government had created one of the conditions that turned the recession of 1929 into the Great Depression. In that earlier time, the New York Clearing House banks allowed the small bank with the big name, Bank of the United States, to fail. After that failure, which would have been so easy to avoid, another 8000 banks failed. Of course, the government at that time had to wait until 1933 for the creation of the FDIC and other tools to stem the runs on the banks.

For a month the government has been improvising various solutions to the Lehman mistake, and often it has looked like making sausages. It hasn’t been pretty, and no one knows whether it will be ultimately effective. But the actions of the Euro-zone countries, after their initial stumble, are encouraging. Likewise, the reaction to the revised Paulson plan, which has morphed from buying $700 billion in mortgages to providing a much needed $250 billion in new bank capital, also appears positive. It is possible that we have seen a version of 1929-1933 play out in a very short time (as events are often accelerated these days). But there was still a long way to go for the US economy to recover after 1933.

UPDATE
— Andy Kessler has a good summary in the WSJ of what US and European authorities are trying to do with their remedial measures.

One Response to “The shame of 9/15/2008”

  1. feeblemind Says:

    Well . . . I am still of the opinion that the Government should have stayed out of the way and let the chips fall where they may.

    They stopped the crash by printing unlimited amounts of money. A policy cheered by some here at this blog. Once Congress realized it was okay to do that in the name of saving the economy, it was off to the races. Then the world joined in.

    And what do you know? It worked. Silly me. I was wrong. I thought printing money was a bad thing and would end in ruin, but it has been going on for 10 years with no sign of abating and everything is just peachy.

    I guess it’s just all too complex for my feeble mind to comprehend.

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