Thank God For Lehman?

It has almost become the official line (especially in Europe) that the financial crisis of 2008 was caused by the failure of Lehman Brothers and that, had the U.S. authorities (the Fed and/or the Treasury) only saved Lehman, the worst of the crisis would have been averted. It is a convenient way to put all the blame on the U.S. on the one hand and for European governments to justify their own financial bailouts with the motto: "no more Lehmans" on the other.

In an article in The Economist (and in an upcoming book, This Time Is Different: Eight Centuries of Financial Folly), the Harvard economist Kenneth Rogoff makes two crucial points. The first is that, by 2008, the banking system was so sick ("trillions of dollars of debt secured by an inexorably deflating asset bubble") that the failure of a major bank was inevitable. The second, more provocative, point is that Lehman's failure actually paved the way for the subsequent rescue of the whole banking system. It made it a little more politically palatable (but still not really palatable) to save the banks (if not the bankers) and the non-banks (think AIG).

If Mr Rogoff is right and more failures were inevitable, then Lehman’s collapse, though painful, may have been necessary. History suggests that systemic banking crises are usually resolved with large injections of public capital. Lehman’s failure galvanised policymakers. Only when faced with the post-Lehman, post-AIG chaos did Congress pass the $700 billion Troubled Asset Relief Programme (and even then, after an initial rejection). Other rich-country governments also moved to guarantee bank debts, raise deposit insurance and inject capital into their banks.