Thursday, October 16, 2008
Q: Many market participants I talk with think that the way Lehman was allowed to fail caused substantial damage to confidence and to the access to credit of other financial institutions. Do you think that criticism has some merit, and if so how might it have been done differently, and could it be done differently if there were a similar situation under the TARP?
Mr. Bernanke: So, Lehman was not allowed to fail that in the sense there was some choice being made. There was no mechanism, there was no option, there was no set of rules, there was no funding to allow us to address that situation. The Federal Reserve's ability to lend which was used in the Bear Stearns case, for example, requires that adequate collateral be posted so that we are not taking credit risk, we are lending against collateral. In this case that was impossible. There simply wasn't enough collateral to support the lending. From the Treasury's perspective, unlike the FDIC, deposit insurance fund, there were no funds, there was no option. We worked very hard over one of those famous weekends, with not only some potential acquirers of Lehman but we called together many of the leading CEOs of the private sector in New York to try to come to a solution. We didn't find one, and therefore we were unable to do what we wanted very much to do, which was to prevent the failure of the company.
Indeed, Sarkozy recognizes what Merkel seems to have shut her eyes to: Europe, having offered massive guarantees to both depositors and lenders--guarantees that will remain credible only as long as they are not sorely tested--must now ensure that borrowers do not fail, that investor confidence does not crumble, that what Keynes termed "animal spirits" do not flag. Of the more than one trillion euros pledged thus far, only a small fraction involves up-front expenditure: the equity infusion to banks. The rest is in the nature of insurance, a sort of gigantic credit default swap, which, like too many other CDSs, cannot possibly be paid in case of systemic failure. Thus governments have now committed themselves, pace Merkel and Juncker, to making sure that systemic failure does not occur. The question is what form the stimulus will take, not whether it will occur, and it would be good if Europe could achieve coordination on that point as rapidly as it came to agreement on the insurance policy that made such coordination as inevitable as it is essential.
I am reminded of the 1968 Olympics. American athletes raised their clenched fists on the victors' stand in Mexico City, and to judge by the reaction in the States, you would have thought World War III had broken out. The root cause was the same. Minorities, feeling mistreated at home, seized one of the few occasions when their expression would have unquestionable public visibility to manifest their existence and their discontent. Having no use for the proprieties of normal political discourse, they were only too glad to be rapped on the knuckles by sputtering elders. The anger was proof they'd gotten under the skin of the martinets, which is precisely where angry young cut-ups want to be. Outrage and overreaction are hardly remedies, as anyone who has ever dealt with an adolescent (or been one) knows.
The politicians ought to stop their useless scolding and get back to the urgent business of the day. If the United States can stop talking about flags pinned (or not) to the lapels of candidates, France can stop yapping about jeering at soccer games.