Should We Have Let Wall Street Go Bust?

Zócalo Public Square ^ | various

[1rudeboy]

Perspectives on the Much-Hated, Much-Attacked, and Much-Defended Great Bank Bailout of 2008

Unless we were very young or very oblivious, we remember the financial panic that followed the collapse of Lehman Brothers on September 15, 2008. Wall Street ran to Washington and asked to be saved from further collapse, and, within a few weeks, Washington had obliged. Hundreds of billions of dollars in bailout money went to the financial institutions—and their executives—of Wall Street. Today, despite legislation intended to curb some of the speculative excesses of Wall Street, many of the problems that led to the collapse of 2008 appear to have stuck around. And many Americans feel that the bailouts perpetuated more problems than they averted. In advance of the Zócalo event “Can We Fix What’s Wrong With Banking?” we asked several economists, journalists, and other observers of the world of finance to revisit that fateful period. Should we, in late 2008, have let the big banks die?

[1rudeboy]

Commentary from Russ Roberts, David Min, Jeff Connaughton, Nicole Gelinas, James Kwak, and Mike "Mish" Shedlock in order:

• Maybe—but the real problem was, and still is, the coddling of creditors
  
• No, we had to save them—but we should have addressed “Too Big to Fail”
  
• We should have broken them up
  
• We should have let them die—and die hard
  
• We couldn’t let them fail, but we should’ve at least reformed them
  
• The bailout was a mistake—but even bigger blunders now loom

[1rudeboy]

Maybe—but the real problem was, and still is, the coddling of creditors
Russ Roberts

Tough question. It’s like asking whether chemotherapy is worth it even if you’re not sure you’ve got cancer. Neither choice is attractive. Much better to avoid a suspicion of cancer in the first place.

Policymakers faced very unpleasant choices in 2008. It would have been better to have avoided the mistakes that let banks get so large in the first place. The coddling of creditors beginning with Continental Illinois in 1984 encouraged lenders to be reckless even as banks became increasingly leveraged. The potential for creditor rescue encouraged banks to become larger and more interconnected.

The key question is whether we should have let the first big bank die in March 2008—Bear Stearns. Letting Bear Stears go bankrupt might have had unpleasant consequences. But by making sure that all of Bear’s creditors received 100 cents on the dollar when its obligations were assumed by JP Morgan Chase, the government sent a powerful signal to the market that lenders would be made whole once again, despite having made lousy loans.

When Lehman Brothers was allowed to go bankrupt, Reserve Primary, a money market fund, “broke the buck” and helped create the panic, such as it was, when Lehman died. But why did a money market fund lend to Lehman Brothers when it was well-known that Lehman’s balance sheet looked a lot like Bear’s? Surely Reserve Primary reasoned that Lehman’s creditors would be rescued—so why not take the extra return that Lehman offered? Had Bear been allowed to die, the subsequent damage would have been smaller.

The coddling of creditors is the single most damaging policy mistake of the past three decades. If we can stop the cycle of creditor rescue, banks will shrink naturally and too-big-to-fail will no longer be relevant.

Russ Roberts is a research fellow at Stanford University's Hoover Institution and the host of the award-winning podcast, EconTalk.

[RedHeeler]

Yes. They should have died. We should be planning to kill those, that surpassed. No biggie, thanks for asking.

[Sioux-san]

Agreed - anyone who doesn’t believe this was set into play for the destruction of Free Sovereign Nations is either blind or on the Enemies’ side.

[L,TOWM]

While I mostly agree with Nicole Gelinas premises, I strongly disagree with her conclusion. Had we let the banks “die and die hard”, we probably would not be debating this issue today. We would be too busy shooting each other over the last cans of tuna fish in this country.

DC had a set of bad choices in 2008 and decided to try and keep credit, the lifeblood of our economy, somewhat flowing. I believe that they did about 60% of what needed to be done. More work needs to be done, especially in the swap, reinsurance, derivative, and hedge fund area. I would really like to see the largest financial firms get broken up into smaller business segments and truly get the depository institutions out of the risk business period.

Sooner or later, some od these greedy bastards are going think they are smarter than they actually are and this problem will come about again. The big question at that point is whether the US government, already starting to lose its luster as the “ultimate safest borrower”, will actually have the ability to effectively intervene next time.

[P.O.E.]

“Fear the Boom and Bust” a Hayek vs. Keynes Rap Anthem
http://www.youtube.com/watch?v=d0nERTFo-Sk

[RedHeeler]

Same weakness- blind for evil, evil for blind. Don’t know how that works. Seems to be the same, no matter , for a long time. Take good care, Sioux-san

[TabithaBliss]

Heck yes!
They are a threat to our liberty! That’s why some lawmakers on BOTH SIDES want to downsize them now..
“Banks too big to jail, fail or nail face new scrutiny”
http://www.cbsnews.com/8301-500395_162-57574423/banks-too-big-to-jail-fail-or-nail-face-new-scrutiny/

[1010RD]

Great mention of Continental Illinois, the one that started it all. It’s the forgotten monster of unintended consequences.

[1rudeboy]

I remember thinking at the time, “nothing good will come of it.” (Of course, I didn’t predict anything).

[dfwgator]

Yes. Bad decisions should lead to bad consequences. Instead, we have a system where profits are privatized and losses are socialized.

[1010RD]

I remember all the rationalizations and IIRC they were the same this time as well.

[Soul of the South]

Critical reforms needed:

Return to Glass Steagall. Reinstate the wall between commercial banks and securities firms. Banks should not be speculating with depositor money.

Make the executives responsible for the decision making leading up to a liquidity crisis at a financial institution feel financial pain for their bad decisions in the event of bankruptcy or government bailout. If a bank files for bankruptcy or requests government assistance, minimally the top 3 layers of executive management should be required to immediately refund the prior three years of bonus and stock incentives received as well as surrender all unexercised stock options. In addition, those executives should be ineligible to receive bonus or incentive compensation from any public institution for 5 years into the future nor an increase in base compensation greater than the CPI.

To begin instilling a sense of accountability and personal responsibility in all layers of management, managers and executives below the top tiers should also be required to refund incentive payments from prior years and forego future incentive compensation. I would propose a 50% haircut on them for incentive compensation and equity exercises during the previous three years and ban them from receiving stock options or bonus payments from any publicly held company for the next three years.

Members of the boards of directors of a bank filing for bankruptcy protection or requesting government assistance should also be required to surrender all compensation (pay and equity) received the prior three years and any stock options granted. They should be fired, replaced and prohibited from serving on the board of any US corporation for a period of 5 years.

One of the great crimes of the 2008 bailout was the banks immediately returning to paying large bonuses and stock option grants to the same executives who went to the taxpayer with cup in hand. In the years immediately following the bailouts, their banks were being propped up by the taxpayer and Federal Reserve while they rebuilt their balance sheets and payed themselves large bonuses for “improved” performance. If executives are going to be handsomely rewarded in good times, they should also be penalized financially when they make poor choices.

True entrepreneurs in our system pay the ultimate penalty in the event of bankruptcy, they lose their personal net worth and jobs. It is time for professional management of financial firms to also have their personal financial fortunes more aligned to the consequences of the decisions they make. An executive who takes a high risk bet in today’s world may face loss of a bonus for a year or no consequences at all. If he takes risk, knowing he may be wiped out financially if the risk fails, he or she may become better at evaluating risks and will likely avoid risks that may bring down the company.

[reed13k]

I’m in the die hard crowd. Had we allowed the process to work they would have declared bankruptcy. the court would have provided for administration of customer funds and creditors would have received their due. Instead between the GM and later MF Global debacles we have subverted the rules of contract and law and converted to a 100% pay to play mentality where the AG won’t even consider prosecution despite laws being broken.

[LibLieSlayer]

Yes, without a single doubt.

LLS

[dfwgator]

What people don’t realize is that Wall Street gets all of the benefits of taking on risk, while being able to pass that risk off on the taxpayers.

[expat_panama]

"...Wall Street ran to Washington and asked to be saved..."

Let's all finish our play time and revisit the planet earth.  This is Wall St.:

(click image for larger size)

For hundreds of years that where it's been and it never once 'ran to Washington' or anywhere else for that matter.  OK, so maybe he meant them rich pin-stripe banker traders types.  Yeah right.   OK, so he's really talking about the "hundreds of billions of dollars in bailout money went to the financial institutions—and their executives—of Wall Street."  So when "hundreds of billions of dollars" were paid back we call that Washington running to Wall St. begging for a reverse bailout?

Hardly

[SaraJohnson]

Corrupt global fascists making dirty debt deals with corrupt global socialists. Death penality.