Mohamed El-Erian of Pimco is a fellow who usually knows what he’s talking about. FT:
History books will document that the global economy experienced a sudden stop after September 15. In accentuating long-standing structural weaknesses, the manner in which Lehman Brothers failed disrupted the trust that underpins the smooth functioning of market economies. As a result, virtually every indicator of economic and financial relationships exhibits characteristics of cardiac arrest.
The situation will get worse before it gets better and it will only get better if there is a shift in thinking in both the private and public sectors: away from comforting yet unrealistic notions of a return to “business as usual” and towards the more nasty reality of a volatile journey to a different destination. The implications are far-reaching as they speak to more market accidents, disorderly sectoral realignments and additional shifts in policy.
Up to September 15, debate focused on moral hazard, or the extent to which government bail-outs encourage irresponsible behaviour. The need to signal the government’s seriousness about market discipline partly drove the decision to let Lehman fail. What was less well understood was that it matters a great deal how an institution’s failure affects the capital structure.
The way Lehman failed disrupted payments and settlements. Around the world, market participants stepped back in mass from what, up to then, were standardised, routine, predictable transactions. Not surprisingly, all main indicators are now violently heading south. It is not just about consumption, investment and employment in the US, which will result in a 4 per cent plus contraction in gross domestic product in this quarter alone. It is also about pressures on production in Brazil, China, Japan and Russia, as well as the slowdown in construction in the Gulf. What we are witnessing goes well beyond a cyclical economic shock and a consolidation of the financial sector.
We have said that letting Lehman fail was a big, possibly calamitous mistake. It does not help matters that the Fed Chairman continues to obfuscate this situation. Much of the financial world pretty much ceased functioning 80 days ago, and banking is like a river that brings life to the modern world of commerce. This needs to be fixed, and fast, but unfortunately this is probably a situation that can’t be remediated in short order.