July 8, 2012


The 5 myths of the great financial meltdown (Allan Sloan, June 13, 2012, Fortune)

Myth No. 1: The government should have done nothing.

There's an idea gaining currency that everything the government did, from the Troubled Asset Relief Program (the now infamous TARP) to the Federal Reserve's innovative lending programs and rate cutting, just made the problem worse. And that we should have simply let markets do their thing.

Wrong! Wrong! Wrong! During the dark days of 2008-09, when giant institutions like Washington Mutual and Wachovia and Lehman Brothers failed and the likes of Citigroup (C), Bank of America (BAC), AIG (AIG), GE Capital (GE), Merrill Lynch, Morgan Stanley (MS), Goldman Sachs (GS), and huge European banks were near collapse, letting them all go under would have brought on the financial apocalypse. We could well have ended up with a downturn worse than the Great Depression, which was the previous time that failures in the financial system (rather than the Federal Reserve raising rates) begat a U.S. economic slowdown.

You want to let big institutions fail? Okay, look at what happened when Lehman was allowed to go under in September 2008. (The Treasury and Fed insist there was no way to save the firm, though I wonder if they would have devised one had they not gotten tons of grief six months earlier for not letting Bear Stearns collapse.)

Lehman's collapse froze short-term money markets, making normal finance impossible. A run on money-market funds began when the Reserve Primary Fund, an industry pioneer, said it was "breaking the buck" because of losses on Lehman paper. Goldman Sachs and Morgan Stanley were about to fail because hedge funds and other "prime brokerage" customers began yanking their cash in response to prime brokerage assets at Lehman's London branch being frozen.

The federal government (including the Fed) had to front trillions of dollars and guarantee trillions of obligations -- a total I calculated last year (see "Surprise! The Big Bad Bailout Is Paying Off") at more than $14 trillion -- to stop the panic.

Lehman was a beta test for letting markets take care of problems themselves -- and it failed miserably.

Posted by at July 8, 2012 8:15 AM

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