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Friday, September 20, 2013

The lessons of Lehman Brothers–not learned

Since it’s five years past the collapse of Lehman Brothers, there have been a lot of retrospective articles.

Many of these seem to imply a close connection between the collapse of Lehman and the long recession / slow recovery we’ve been in, e.g.  “Five years after Lehman Brothers collapsed, Western economies are at last beginning to recover” (Jeremy Warner, The Telegraph, London).  Henry Paulsen has also been on TV a lot, regretting that his hands were tied and he didn’t have the authority to save Lehman, and other “Regulators have since argued that there was no authority to save Lehman”.

This implies that we should have saved Lehman, and if we had we wouldn’t have had the recession (or a severe a recession). I can’t find instances where people have said that directly; they aren’t that stupid. It just gets implied by the close association of sentences.

Yes, the recession has been going on for five years, and the collapse of Lehman is a convenient time to remind us of this fact. 

Points that get ignored

But, no, we would not have avoided this recession if we had saved Lehman. I’ll let future economic historians figure out whether Lehman failing made the future more (or less) bleak, if they can.  But I’ll point out a few salient facts.

1. In a bubble -- and highly leveraged junk AAA mortgage bonds and the housing speculation they were associated with were surely a bubble -- the bubble eventually breaks.  There may be a precipitating event to that break, but the precipitating event didn’t cause the bubble, and some other event would eventually have pricked the bubble and caused collapse.

  • Lehman certainly participated in the events causing the bubble, but was not alone, and wasn’t the largest player.
  • An analogy: suppose a car going across a bridge skids on the ice and hits a girder at low speed – and the bridge collapses.  The car was the precipitating cause of the collapse, and certainly didn’t do the bridge any good, but the bridge was poorly engineered (or poorly maintained) and likely would have collapsed at a different time.

2. Housing was already slowing more than a year before.  In 2007, I had to sell my father’s house in Missouri. The local market was characterized by high levels of inventory, few sales, and some conversions from sales inventory to rentals – much different than the local market had been the year before.  These are all bad signs if you are trying to sell a house. 

  • I figured I needed to get rid of the house quickly, or we were likely to have it for a long time. This is over a year ahead of Lehman. 
  • Articles in the business press (WSJ) early in 2007 noted the excess of liquidity in the overall markets (Wall Street running out of things to buy at reasonable prices), another sign the bubble was near an end over a year before.

It’s a PR diversion

3. The current attempt to imply that it’s the failure to save Lehman that caused the recession works well as Wall Street propaganda. 

  • It diverts attention from the misfeasance, malfeasance, and nonfeasance of that era (where almost no prosecutions have occurred).
  • It implies that we should forget the moral hazard lesson (if you mess up in business, you fail) in favor of a too big to fail lesson (this will hurt you more than it will hurt me).
  • It diverts attention from the fact that part of the problem with needing bailouts was that some firms were deemed “too big to fail” – but the largest entities are much larger now than they were in 2008, and governments worldwide don’t seem to want to deal with making them smaller in any way. We have been determined not to learn the lesson that if banks are “too big to fail” then they should be made smaller.
    • As a side note, I would note that these banks are private enterprises (e.g. owned by stockholders) but are not operating in a capitalist system, or a socialist system, but in a sector somewhere in between. A set of purely capitalist banks would be a much different system than we have now in Western countries.
  • It diverts attention from the looming financial crisis bubble of underfunded pensions, which is a joint problem of government and Wall Street. The problem is mostly due to governments promising more than they funded, leaving problems to be dealt with later. But Wall Street firms aren’t blameless either.  These public pension funds have been a source of rich fees, which have been unrelated to performance. (See http://mikekr.blogspot.com/2013/07/fwd-high-fees-dont-lead-to-better.html )  At least in Illinois, they have led to a variety of corruption issues. 
    • Note added later (Sept 26, 2013): Matt Tiabi has a new article in Rolling Stone; I’ve just read the interview here, but from the headline, “
    • Matt Taibbi on How Wall Street Hedge Funds Are Looting the Pension Funds of Public Workers

      I think it’s likely he agrees with me that Wall Street firms have much to answer for in the pension crisis (although still the main problem is with governments promising benefits they did not set aside money for).