« Breaking the CNN Habit | Main | "The Time has Come" »

Wednesday, August 12, 2009

Would Saving Lehman Have Saved the Economy?

Ken Rogoff:

The Confidence Game, by Kenneth Rogoff, Commentary, Project Syndicate: Next month marks the one year anniversary of the collapse of ... Lehman Brothers. The fall of Lehman marked the onset of a global recession and financial crisis the likes of which the world has not seen since the Great Depression of the 1930’s. ...
The overwhelming consensus in the policy community is that if only the government had bailed out Lehman, the whole thing would have been a hiccup and not a heart attack. Famous investors and leading policymakers alike have opined that in our ultra-interconnected global economy, a big financial institution like Lehman can never be allowed to fail. ...
Unfortunately, the conventional post-mortem on Lehman is wishful thinking. It basically says that no matter how huge the housing bubble, how deep a credit hole the United States (and many other countries) had dug, and how convoluted the global financial system, we could have just grown our way out of trouble. Patch up Lehman, move on,... and nothing bad ever need have happened.
The fact is global imbalances in debt and asset prices had been building up to a crescendo for years, and ... there was no easy way out. The United States was showing all the warning signs of a deep financial crisis long in advance of Lehman...
The entire financial system was totally unprepared to deal with the inevitable collapse of the housing and credit bubbles. The system had reached a point where it had to be bailed out and restructured. And there is no realistic political or legal scenario where such a bailout could have been executed without some blood on the streets. Hence, the fall of a large bank or investment bank was inevitable as a catalyst to action.
The problem with letting Lehman go under was not the concept but the execution. The government should have moved in aggressively to cushion the workout of Lehman’s complex derivative book, even if this meant creative legal interpretations or pushing through new laws...
The right lesson from Lehman should be that the global financial system needs major changes in regulation and governance. The current safety net approach may work in the short term but will ultimately lead to ballooning and unsustainable government debts, particularly in the US and Europe.
Asia may be willing to sponsor the west for now, but not in perpetuity. ... Within a few years, western governments will have to sharply raise taxes, inflate, partially default, or some combination of all three. As painful as it may seem, it would be far better to start bringing fundamentals in line now. ...

The "hiccup not a heart attack" sets up a false comparison. Had Lehman been bailed out things might not have been quite so bad, or followed a slower downward trajectory, but it wouldn't have been just a hiccup. I don't think many people make the claim that "Patch up Lehman,... and nothing bad ever need have happened."

But the main thing I want to know is if he saying we should start balancing the budget and tightening monetary policy right now, at the trough of the cycle. It seems like that's the message at the end, but I must be reading it wrong.

    Posted by on Wednesday, August 12, 2009 at 12:33 AM Permalink  Comments (54)


    Feed You can follow this conversation by subscribing to the comment feed for this post.