More On Wall Street
Well the first ‘post Lehman’ morning has come and gone. The stock market is clearly shaken, but did not collapse either. Plenty of investment bankers are busy sharpening up their resumes. Media experts are opining. And both presidential candidates have waded in with comments.
My early observations: McCain is dead wrong. The collapse of Lehman and Merrill Lynch is not a sign or result of the failure of too much government regulation. It is exactly the opposite: lax government regulation helped create this mess. Back in the day, when I was in banking myself, the laws separating investment banking and commercial banking were removed. The effort was to unleash ‘market forces’ and allow them to shape the future instead of giving that role to government regulation. The only problem was that the rules that remained, such things as mandatory capital requirements etc, were imposed on the mainstream banks and not on the so-called ‘shadow financial system’ were players like Bear Stearns, Lehman, and Merrill Lynch roamed unfettered by much oversight. Yet those companies, and the various banks they did business with [their ‘counterparties’ in the industry jargon] all implicitly assumed that there was a government provided safety net should they fail or threaten to fail. In economics this is called the ‘moral hazard’ problem. In short the assumed safety net allowed these unregulated banks to play for big gains with ever increasing risk safe in the knowledge that they would not be allowed to fail. The high street banks like Citibank and Bank of America are covered by regulations that limit their activities somewhat: in return their deposits are insured by the FDIC which provides those banks retail customers with a security that players in the riskier games of the other Wall Street banks don’t get. Or shouldn’t get.
When Bear Stearns failed as a result of its incompetence the government did indeed step in and provide significant aid to J. P. Morgan Chase who thereupon bought out the Bear Stearns assets. So Bear Stearns was aided by the government even though it had never been subject to regulation, and moral hazard reared its ugly head.
This is why McCain has it so wrong: if the taxpayers are going to bear the brunt of bailing out Wall Street, then the banks being bailed out, and those buying up the assets with government guarantees, should fall into the regulator’s realm. Their activities should be subject to greater and more public scrutiny. Perhaps they should even try to understand the securities they are buying and selling! In other words once taxpayer money can be used to bail out a bank, or anyone else for that matter, the taxpayers have a right to set the conditions and rules that the companies involved play by.
Ultimately that message seems to have sunk in at the Treasury department: Lehman has been forced into bankruptcy precisely because the government refused to step in and provide the guarantees needed for another bank to ‘save’ the day. In this case Barclays Bank, a huge British bank, stepped away at the last minute when they could not get those guarantees.
And so Lehman and Merrill are gone. That leaves Goldman and Morgan Stanley as the two remaining major US based investment banks. Let’s hope that the credit crunch abates soon. Otherwise more failures [Washington Mutual? AIG?] are almost certain to occur and the economy will suffer even more than it has.
