Trying to make up for letting Lehman Brothers fail

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.

3 Responses to “Trying to make up for letting Lehman Brothers fail”

  1. Canucklehead Says:

    When we talk about the Euro-zone deal, a couple of points still puzzle me.

    Firstly, can the taxpayer afford it? The numbers put forth are simply staggering for a composite economy that is roughly the size of the United States.

    Secondly, once each Euro country has one or more nationalized banks (or significant taxpayer ownership), how do they compete against one another? Would the financial market be segmented along national ologopolistic lines? How can you unwind this situation once it develops?

    For example, the Icelandic banks (not an EU member) have been nationalized and significant taxpayer ownership has resulted. How do they compete? If they can’t compete, how are they allowed to merge or fail? If merged, what are the political ramifications?

    I don’t see this strengthening the EU. This puts the EU into the ER.

  2. Canucklehead Says:

    The more I think about this, the more this EU situation reminds me of the Alvin Hamilton character’s machinations in the HBO series of “John Adams”.

  3. Paul from Florida Says:

    The feds literally couldn’t run a whorehouse in Vegas, and they are supposed to fix this? They caused it!

    We might as well nationalize the banks. The money is nationalized. The economy is run out of Washington, what the heck are a couple of banks? The only losers left to lose is the Wall Street crew. Make’m all GS -14 and give them Hondas.

    The government already demands private banks lend, and guess what, it puts them out of business. Now the few remaining private banks are supposed to compete with BUSH-FRANK’N GOLDMAN, Inc , very very very LLC.

    Get it over with and let us proles get on with our amusements. Walk the remaining banks into the woodline and have them kneel down and take two to the head like good little heroes of the planned economy.

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