Why Lehman’s Failure Was The Right Move

Millions of gallons of ink must have been consumed in the neverending discussions about the “disaster” represented by the US Government’s decision to let Lehman Brothers fail and disappear. Andrew Ross Sorkin on today’s IHT agrees:

With hindsight, many in the financial industry blame a deepening of the global financial crisis on the government’s decision to let Lehman crumble

I disagree with that analysis, for two very simple reasons. When Lehman was allowed to go bankrupt, a signal was sent to all, saying that not everybody will be rescued. This was in direct contrast with the Japanese Government’s decadal efforts to prop up every financial institution under its watch (that’s why those efforts lasted for a decade or even more).

More importantly, the failure of Lehman Brothers showed everybody what the failure of “just a bank” may mean, with innumerable, overwhelmingly negative consequences propping up even in unlikely places. And this was good: because it is in the human nature to seriously question people advising that something bad may be happening in the near future, and to need a direct experience of that “something bad” before properly reacting.

You can spend every last molecule of your breath explaining a child that eating too many sweets can be painful. But there is nothing like going through a “tummy ache” that will convince the child of changing their way.

And you could transfer yourself back to January 1939 and explain all the reasons for the upcoming Nazi continent-wide monstruosity, but I am sure nobody in the UK or France (or the USA) will agree to go to war until forced to by the pain of circumstance.

And so, had Lehman Brothers been rescued alongside the other relatively large institutions, we would still be discussing the pro’s and con’s of rescue packages. And we would have never known that it takes just a bank to fail, to see a run on money-market funds.

Hindsight will fuel further commentaries on now-defunct Lehman Brothers: and hindsight can be useful to make sense of the world, but only works when there is something to look back at…

Why Lehman Brothers Was Let Go

Because Lehman Brothers was not “too big to fail” (*).

All in all, had the US Treasury intervened to save Lehman too, it would have been even more worrying, as it have signalled a green light for further recklessness.

(*) Given what has happened in the past with companies filing for bankruptcy protection in the US, the actual complete demise of Lehman Brothers may be slightly exaggerated