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The Decision to Let Lehman Fail

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Sunday, 23 February 2014 09:23

Gretchen Morgensen picks up an important point in the Fed transcripts from 2008. The discussion around the decision to allow Lehman to go bankrupt makes it very clear that it was a decision. In other words the Fed did not rescue Lehman because it chose not to.

This is important because the key regulators involved in this decision, Ben Bernanke, Hank Paulson, and Timothy Geithner, have been allowed to rewrite history and claim that they didn't rescue Lehman because they lacked the legal authority to rescue it. This is transparent tripe, which should be evident to any knowledgeable observer. (Who has legal standing to stop a bailout?)

Anyhow, in retrospect the choice not to rescue Lehman in a context where the Fed was unprepared to deal with the consequences certainly was disastrous. We all make mistakes, but this gang of three made a whopper. And reporters have an obligation to make this clear to the public, not to assist in the cover-up.

Btw, on the topic of whopper mistakes, someone sent me this collection of Bernanke clips on the housing bubble.

Comments (8)Add Comment
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written by Benedict@Large, February 23, 2014 2:16
Cui bono?
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written by Brett, February 23, 2014 2:50
If they've been pushing that line, it hasn't been working. I just watched PBS's Money, Power, and Wall Street, and they openly say that Geithner and Paulson decided to let Lehman Bros fail because they were worried about moral hazard after bailing out Bear Stearns.

Why Geithner was made Treasury Secretary after that and his inability to actually put any conditionality on bailouts for the major banks is beyond me.
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written by watermelonpunch, February 23, 2014 3:13
written by Brett, February 23, 2014 2:50
Why Geithner was made Treasury Secretary after that and his inability to actually put any conditionality on bailouts for the major banks is beyond me.


If my father were still alive (he's not), he would, I know, be convinced there were kickbacks involved somehow.
And I think his suspicions would be quite understandable.
Slobbering Hank Paulson
written by Last Mover, February 23, 2014 6:06

Let's see, to discourage banks who think they are TBTF from going all moral hazard on America for a bailout, Lehman is denied a bailout after Bear Stearns got one.

Meanwhile both are bought up by other banks in the carnage aftermath leaving the industry more concentrated than before, with fewer but effectively even bigger TBTF banks, not to mention executives rewarded with bonuses and get-out-of-jail-free cards for enduring such hardship.

And to top it off, we have blank-check-bailout Hank Paulson slobbering that his hero Ben Bernanke saved America from a second Great Depression.

Wow. Like you know, what a difference it would have made if Bear Stearns had been denied a bailout, or in the other direction if Lehman had been bailed out.

Like the inherent TBTF status granted permanently to the financial industry would have really changed either way wouldn't it, and they wouldn't keep on winning whether it's heads or tails would they.

Like Hank Paulson wouldn't be slobbering either way would he. No sireee America, if the Fed and Treasury had slipped just one inch either way on the tightrope to a safe recovery, Hank Paulson would be standing tall right about now, chastising everyone for what they did wrong and what they should have done to avoid the Second Great Depression they ended up with.

But Hank Paulson gets to slobber doesn't he, because Americans deserve the Great Recession given to them instead by Hank Paulson and his pals in the 1% don't they.
So AIG should still be writing credit default swaps on whatever?
written by tinbox, February 23, 2014 10:39
Without going down the whole Mellon liquidationist route, surely there was nothing at Lehman worth "saving." It was a bankrupt, poorly managed company that provided no useful services to others.

How was the Fed to know what the consequences of Lehman's bankruptcy would be ahead of time?
Too Big to Fail
written by Dave, February 24, 2014 8:05
@brett:

If you read "Too Big to Fail" by Andrew Ross Sorkin, this fact is obvious also. Reading that book makes it even more clear that it was Paulson that was the ringleader of this decision, and that he had much closer ties to Geithner than Bernanke in making the decision as you say.

That book also makes it clear that Paulson had a rivalry with Lehman (to put it nicely). Actually, Hank hated Lehman, which is most likely why he chose to make it the example rather than Bear Stearns.
Bernanke's Actions
written by Dave, February 24, 2014 8:11
The clips on Bernanke's position on housing are interesting, but you have to understand the context of his position and actions rather than just the words to get the full picture.

In his initial comments from 2005, he was working under Greenspan. Saying anything different would have been viewed as insubordination at the Fed. In later comments Ben shows his ignorance of the ramifications of the housing bubble, and he seems ignorant of the causes of the collapse of the bubble. He seems focussed on subprime as all of the financial types were.

Nevertheless, Bernanke's actions on fed rates show a clear desire to reign in the housing bubble. If you asked Bernanke the question, "Knowing what happened, do you regret your decisions" he might say yes, he might say know. But that is irrelevant. The fact is that the housing bubble needed deflating, and whether the full effects were known prior is not relevant. His actions proved he wanted it to deflate. Perhaps he was rationalizing the outcome as being not so bad. I contended that even though the outcome was worse than he expected, it was still the best outcome.

The only tragedy is that the people in charge didn't seem to learn anything, and they still don't seem to understand their own system. They are in massive denial as are many prominent economists about the obsolescence of the old monetary models.
...
written by liberal, February 24, 2014 12:46
Dave wrote,
The only tragedy is that the people in charge didn't seem to learn anything...


The real tragedy is that most people, even normally "good" economists like Dean, don't understand the role land rent plays in an economy, and why it leads to a never-ending stream of real estate bubbles. (Though that's not even necessarily the worst thing about it.)

Note that, while Dean was among the earliest in seeing the bubble, by far the earliest prognosticator was a Georgist.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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