Revisionist History, Financial Crisis Edition
In the last few months, I’ve been seeing a new meme popping up in conservative/libertarian circles, which basically holds that:
1. Letting Lehman die wasn’t especially costly, didn’t pose a systemic risk, and wasn’t a mistake.
2. A bankruptcy of AIG likewise would not have posed any systemic risk; as such, the Fed shouldn’t have bailed out AIG.
I first saw hints of this meme in a WSJ op-ed blaming blamed government actions, not Lehman’s BK, for the worsening of the financial crisis. Then came a debate with one of my more conservative friends, who suggested that an AIG bankruptcy really wouldn’t have been all that bad. Now we have Wallison suggesting more or less the same thing.
Re. #1: Anyone reading Across the Curve in the days following 15 September 2008 would’ve been well aware of the credit-market panic spawned by Lehman’s downfall & the aftereffects thereof. We also have this BIS article (164 KB PDF), and Sec. 6 of this ICI report (2.8 MB PDF), which both discuss how Lehman’s downfall spawned a run on the money-market funds. See also James Surowiecki & Sam Jones for more debunking of this aspect of the meme; I tend to agree with the latter’s rather balanced take:
It was thus in context that the decision to allow Lehman to collapse was a failure. A Lehman failure didn’t have to spell disaster- it could, perhaps should, have occurred alongside an announcement of a generalised guarantee on money market funds – as well as a broad commitment from the Fed to extend its liquidity facilities. That such announcements in reality, came a week later was no good.
In a world in which Lehman had survived, would a TARP ever have made it through Congress? After a Lehman bailout, would AIG have ended up a victim: a bailout too far? (If so, the consequences would have been far worse.)
So Lehman’s bankruptcy didn’t necessarily have systemic implications, given appropriate precautions (e.g., guarantees for money-market funds, liquidity facilities) by the Fed, FDIC, etc., on the day of said bankruptcy. But, of course, such actions would still have lacked the ideological purity associated with refraining from any post-bankruptcy governmental interventions.
As for #2, Felix Salmon explains the risks associated with letting AIG’s Financial Products division fail. Moreover, David Merkel, who knows a thing or two about the insurance industry, thoroughly analyzed AIG’s finances, and concluded that not only AIGFP, but also many of its life insurance subsidiaries, probably would’ve failed absent a federal bailout. (Although, in theory, bailing out those subsidiaries could’ve been left to states’ insurance guarantee funds, doing so would’ve weakened solvent life insurers, and possibly led to even more life insurer failures.) There’s also this AIG report, pp. 9-10 of which no longer seem so overblown in view of Merkel’s analysis.
Perhaps it’s true that a “hands off” approach to bankruptcies by both AIG & Lehman would’ve yielded a better outcome than OTL. In view of the above, however, it’s understandable that policymakers were unwilling to take the risks associated with such course of action.