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Lehman Brothers Revisited

Lehman Brothers Revisited

As we pass the one year anniversary of the fall of Lehman Brothers, journalists,
politicians and market analysts have seized on the occasion to offer seemingly sober
assessments of what went wrong and what went right in the lead up and aftermath
of the biggest financial event since Black Tuesday.

The most popular storyline offered by these Monday morning quarterbacks is that the
mistaken decision to allow Lehman to fail resulted from the Bush
Administration’s misplaced faith in the free markets. In this telling, the real
crises began in the days following the Lehman bankruptcy, which unleashed a
financial panic that would have caused complete economic collapse – if not for
the subsequent federal intervention.

In reality, Lehman’s demise was simply the result of an unfolding crisis that
began years before. Popular belief aside, allowing the institution to succumb
to the overwhelming debts on its balance sheet was perhaps the only correct
decision made by government since this crisis began. The propagandists’
complete reversal of cause and effect now threatens to spur the government to
compound prior mistakes and bring on the next phase of the financial crisis. Unfortunately,
this chapter will likely be much more dangerous than what we saw last
fall.

In March of 2008, in the aftermath of the Bear Sterns “bailout??? (which itself was
a major mistake), equity shareholders walked away with a generous ten dollars
per share, all creditors were made whole, and most employees got jobs and
bonuses from JP Morgan. As a result of this largess, the Fed created a very
serious problem for itself. After Bear, the perception took hold that
investment banks were too “interconnected??? to fail. The resulting moral hazard
decreased the financial stability of the banking system and exposed taxpayers
to open-ended risks. The Bush administration rightly determined that a
message needed to be sent that Bear was an isolated case, and that capitalism
still held sway on Wall Street. The fall of Lehman, which was helped along by
the unrealistic recalcitrance of its chairman Richard Fuld, would be that clear
signal.

However, politics quickly trumped economics, and the Lehman trial balloon soon turned
into the Hindenburg. Washington
had no stomach for the ensuing financial carnage, and when other institutions
began to topple, Bush, Paulson and Bernanke abandoned their prior convictions
and threw all they had into the ensuing bailout bonanza. As a result, the moral
hazard that they had sought to avoid now exists on a scale unprecedented in our
history. Capitalism has been extinguished on Wall Street, and our
financial institutions now exist as public utilities. The presidents of our
biggest banks are now the highest paid civil servants in the world!

Since market forces are no longer allowed to allocate capital and control risk, these
decisions are now made by government regulators and are then passed through to
their subordinates on Wall Street. This perverse organizational structure
constitutes a new form of American fascism.

The pain of allowing Lehman to fail will be dwarfed by the agony of bailing out the
rest of Wall Street, which is now a foregone conclusion. Just because the
Lehman bankruptcy created unpleasant consequences does not mean it was a
mistake. On the contrary, sometimes doing the right thing hurts –
especially if it is done to avoid even greater pain down the road. It just
seems that our representatives are incapable of asking for short-term
sacrifice. There is no price they are not willing to force the rest of us
to pay to assure their own reelection.

In reward for its gross culpability in creating the financial crisis, the Federal
Reserve has been rewarded with extensive new powers. Given the damage it was
able to inflict in the past, I can only imagine the havoc that will be wrought
by the new “Super Fed.???

If the current policies continue, the America
we know – for which our forebears risked so much – will cease to exist. The
constitution originally established by our Founding Fathers has been under
attack almost since inception. Up until now, the greatest damage occurred
during Roosevelt’s New Deal. However, the
current assault on our birthright could be a knockout blow. The last vestige of
republican government now hangs in the balance.

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