At a House Financial Services Committee hearing just after Lehman Brothers filed for bankruptcy protection a year ago, the committee chairman, Barney Frank, suggested that September 15, 2008 be commemorated as Free Market Day, since Lehman was allowed to fail and free markets allowed to work. Frank then added that because AIG was bailed out the next day, “the national commitment to the free market lasted one day.”
Funny guy, the chairman — but probably not to Ben Bernanke, Hank Paulson, or Timothy Geithner. They’re the folks, obviously, who get the blame for not ginning up some way — any way — to bail out the investment bank and avoid a dangerous escalation of the financial crisis.
At last check, both Bernanke and Paulson steadfastly maintain that legally their hands were tied, thus the need for expanded authority to take over and wind down failing financial firms. If such authority had existed, Bernanke said a month after Lehman’s implosion, “we could have saved it. We would have saved it.”
Of course, that explanation seems to have evolved a bit over time. There are plenty of hints that a way would have been found to save Lehman, had Bernanke and Paulson anticipated the breaking of the buck by the Reserve Primary Fund and the flabbergasted reaction by international investors who had expected a repeat of the Bear Stearns bailout.
Yet in the year since the Lehman collapse, the consensus that it was an unmitigated disaster may be starting to shift. Free Market Day may be worth celebrating after all.
There are a couple of main arguments here. Call one of them the No Real Harm Theory. This has two aspects. First, economist and former Treasury official John Taylor argues that credit spreads didn’t really blow out until the market got a look at the government’s reaction to Lehman’s demise — the hasty construction and apocalyptic selling of the TARP.
At the same time, others argue that given the fragile state of the market, saving Lehman would merely have shifted the spotlight to some other endangered firm.
Then there’s what we’ll call the Worse the Better Theory. It holds that the severe market reaction to Lehman is what persuaded Congress and the Fed that it was time to do whatever it took to stabilize the financial system through bailing out AIG and passing the TARP.
Without Lehman, a continuation of piecemeal fixes would have allowed the financial system to erode further, heightening the chance of depression. What’s more, Lehman exposed the dangerous fragility of our interconnected financial system, serving as a catalyst for reform.
So is the case for letting Lehman die a clear-cut one? No. But it is a reasonable one, and even more so if the government had spent the time between March’s Bear Stearn rescue and Lehman’s chaotic bankruptcy creating a predictable and transparent resolution protocol.
So celebrate Free Market Day? You bet, but make it a quiet dinner rather than a wild party.