To Bailout Lehman or Not Bailout Lehman: Here’s Why It’s the Wrong Question to Ask

As if not enough has been said about Lehman already, I figured I would take the time and chime in myself …

Reading/seeing/hearing the Lehman talk plastered all over the blogosphere, I started remembering some of my thoughts from this time two years ago. First, I think it is important to point out that Lehman’s failure was not a trigger of financial panic, but rather, it was symptomatic of far larger systemic problems. Some will have you believe that had Lehman been saved, this crisis would have been avoided. That is patently false. Lehman’s failure sped up and amplified the panic in credit and equity markets, but do not be lulled into thinking that everything was a-ok before Lehman failed.

Up to that point, Countrywide, Bear Stearns, Freddie Mac and Fannie Mae all had failed in their own ways, which leads to the second important point: Lehman’s demise became inevitable the moment Bear Stearns failed (some might even say it was inevitable when Lehman bought Archstone Properties at the peak of the real estate market…but that’s its own story). Credit default swaps and equity markets all pointed towards the fact that Lehman would be next. Yes, Lehman’s collapse amplified the panic to an extent; no, it did not create the panic. Whether the Fed/Treasury bailed out Lehman, or not, AIG’s failure too was imminent and that carried far larger and more dire consequences for the economy.

At the time, Dick Fuld was the “villain” of the financial crisis (This New York magazine piece sure is a fun read a year later) for his unwillingness to acknowledge the inevitable and sell Lehman to another bank before its failure.   Years ago, Hyman Minsky observed that:

“The triggering device in financial instability may be the financial distress of a particular unit. In such a case, the initiating unit, after the event, will be adjudged guilty of poor management. However, the poor management of this unit…may not be the cause of system instability.”

This is a quote I draw back on quite a bit, as it is as relevant today as it was several decades ago and to me, this remains the single most important lesson to learn about the Lehman failure.  We should not be asking whether or not Lehman should have been bailed out.  Instead, we should be asking ourselves whether enough has been done since that time to improve our system to the point where another Lehman-like failure will not, and should not happen.