Tuesday, August 21, 2012

Part of the revisionist history of the financial crisis that is driving me nuts is the Lehman Brothers bankruptcy. If you listen to the media, the financial crisis was caused by somebody buying a home in Detroit they couldn't afford and Lehman declaring bankruptcy. The financial meltdown in 2008 was the result of reckless behavior by everybody; big spending fiscal policy, incredibly bad monetary policy, reckless borrowers and lenders and incompetent regulators all compounded by Wall Street greed. It was a lethal brew. The Government could have just as easily let Morgan Stanley or Goldman Sachs go out of business as opposed to Lehman. I am not defending Lehman in any way and I believed they deserved to go under. It was the way they were allowed to close that created the subsequent problems in the market especially for commercial paper. By the time Lehman went belly up, Bear Stearns was long gone, Countrywide and Merrill had been absorbed by Bank of America, Fannie Mae and Freddie Mac had been nationalized because of insolvency, IndyMac Bank had been closed, the US Treasury was pumping money into AIG like it was a second job, and Washington Mutual and Wachovia would be gone in the next two weeks. Everyone of these institutions were guilty of too much leverage with a rapidly declining balance sheet. Lehman was the poster child for this problem but it was not an orphan.

Decisions matter. Because this is a presidential election year there is concentrated focus on economic issues. As the public debate rages I think it is important to remember that the country is facing choices in its fiscal policy and these choices will matter. The next administration will be faced with the choice of stimulating the economy or cutting the deficit. It is important to note that not only the policy direction but the implementation of the policy is important. If the policy is to reduce the deficit, it does no good to cut social programs if you concurrently increase defense spending. If you wish to stimulate the economy through tax cuts it matters which segment of the population gets the tax cut. The financial meltdown of 2008 was the direct result of bad choices, it did not have to happen. Hopefully the country will learn from past mistakes, certainly there is no evidence that Wall Street has learned anything i.e. JP Morgan, MF Global, and Knight Capital.

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