In the panicky days of September 2008, a kind of conventional wisdom grew up in the minds of almost all of the Serious People. The failure to "rescue" Lehman Brothers, according to the Con Wiz, was an especially bad mistake on the part of regulators. The government should have arranged a distressed sale by backstopping Lehman's assets against losses.
Of course, not everyone subscribes to this narrative. I've argued for a very long time that refusing to stand athwart markets that had declared Lehman dead several days before it went through the formal process of dying was one of the only wise things the government did during the period. The original sin, if you will, was supplying support for JPMorgan's purchase of Bear Stearns, a policy which made those who did business with Lehman lose interest in the survival of Lehman.
To put it slightly differently, it was obvious to many of us in the summer of 2008 that the academic phrase "moral hazard" had become the reigning philosophy of the market following Bear Stearns. People owed money by an investment bank need not worry about the collapse of the investment bank because the government would protect derivatives counter-parties and bondholders. This created the truly strange situation in which the holders of common stock were more vigilant than creditors about the financial health of investment banks than the creditors.
"After all, the Federal Reserve will give them their money back, re-insure their credit defaults, take another pile of these distressed assets out of the market. And when the dust settles they can go in and poach Lehman’s business and its smarter employees," Michael Lewis wrote in a column published days before Lehman collapsed.
What this [the behavior of John Thain, Dick Fuld, and countless others on Wall Street during 2008] seems to demonstrate is that the market had become badly dysfunctional after the Federal Reserve's backstop of JP Morgan's puchase of Bear Stearns, reliant to a dangerous extent on a confidence that a government safety net was in place. Investors, board members, would-be buyers and executives had all come to rely on this idea. Market discipline had been shattered.
In the intervening years, this became an increasingly lonely position to hold among Serious People. Sure, the public hated bailouts, despised TARP, and felt politicians had betrayed every promise made to the people when Wall Street was handed billions of taxpayer dollars.
But the Serious People were certain that the public didn't get it, that allowing Lehman to collapse nearly destroyed the financial system and almost brought down the global economy, and that "TARP worked."
Among the skeptics we had a few very good people of course. There was Joseph Weisenthal of Business Insider, John Gapper at the Financial Times, Jeremy Warner of the Times of London, University of Pennsylvania Law Professor David Skeel, my brother Brian Carney at the Wall Street Journal, economic historian Anna Schwartz, and Stanford University economist John Taylor.
I've always hoped that some day the truth would out. "Years from now the lesson of Lehman will likely be viewed as exactly the opposite of the conventional wisdom today," I wrote in December of 2008.
The tide may finally be turning. This Sunday magazine for the New York Times this weekend featured a long "exit interview" with former FDIC chair Sheila Bair (her last day was July 8) by Joe Nocera. The theme: Rescuing investment banks is bad policy, and rescuing Bear Stearns was a mistake.
‘They should have let Bear Stearns fail,” Bair says in the opening sentence of the piece.
As I’ve thought about it in the weeks since our interviews, I’ve come to the view that she was absolutely right. “I think that the Bear deal set up an expectation for government intervention that was not really helpful,” she told me. Letting Bear Stearns fail would most likely have sent the right message to the rest of Wall Street, while there was still time, and without creating the kind of chain reaction that the Lehman failure caused. “I’ve always thought,” she said, “that it was really important for everybody to have to play by the same set of rules.”
That didn’t happen in 2008.
With Sheila Bair and Joe Nocera sounding a lot like Anna Schwartz, perhaps some day the conventional wisdom really will come around to the proper understanding of the events of 2008.
But let's not get ahead of ourselves. For now, let's just welcome Bair and Nocera into our camp, where we still wave the black flag of market discipline and dissent from the official narrative of the Serious People.
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