John Cochrane writes
Runs don’t have a single cause, they have a straw that broke the camel’s back. Ask yourself, would simply bailing out Lehman have avoided this whole mess? Obviously not. People saw Lehman go under — and Paulson’s speech, plus short-sale ban, plus everything else going on at the time — and asked themselves, "gee, my bank was investing in the same things Lehman was. I wonder how they’re doing? I’d better pull my money out just to be safe." ("People" here means institutional investors in the shadow-banking system, i.e. prime-brokerage customers, repo investors, derivatives counterparties, asset-backed security investors.)
This gets it backwards. I’ll say more when I can figure out how to phrase it so as not to get death threats, but to be short the entire Lehman-TARP debacle exposed how little control Wall Street had over Washington and that deeply deeply frightening.
However, it was clear in August 2007 that this whole thing was going down on its own. The only question was when and how the Fed was going to stop it. But, they didn’t. They hemmed and hawed about tightropes.
Then in the shocker of shockers they let Lehman go down. At that point who knew what they wouldn’t allow to happen. It was insane.
But, don’t listen to me. Give this another listen, if you missed it the first time around, and then tell me whether or not you think Paulson’s Oct 2008 testimony was what “clued people in” that there might be a problem here.
I agreed with Jim then and I still agree. You can call us supporters of crony capitalists, apologists for plutocracy, etc.
BUT, you might also want to mention the fact that we were right.
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Thursday ~ February 23rd, 2012 at 10:29 am
wrigglefreeabc
> it was clear in August 2007 that this whole thing was going down on its own
august 2007 or august 2008?
Thursday ~ February 23rd, 2012 at 11:36 am
Michelle
It was obvious in 2007 for anyone that was paying attention (which, at that time, was not me). The financial sector started reporting quarter after quarter of negative returns, earnings on the S&P as a whole started dropping mid-year, foreclosures were up 75% over 2006, and the bond yield curve was flat or inverted for most of 2007.
Thursday ~ February 23rd, 2012 at 12:43 pm
Wonks Anonymous
Any comment on popcorn (or “common shock” in Wallison’s phrasing) vs dominoes? It doesn’t necessarily conflict with your story, particularly if one combines it with Sumner’s emphasis on the information imparted by the actions/inactions of the Fed in response to changes in NGDP expectations. But on Lehman specifically, Taylor’s graph on the market response seems pretty relevant to me. Concluding that Paulson’s speech was responsible would be post hoc fallacy, but other knowledge that became public at that time could have caused expectations to plummet.
Thursday ~ February 23rd, 2012 at 1:15 pm
IVV
Something was Definitely Very Wrong back in August 2007. It might not have been clear everywhere, though. I moved from California to New Jersey during that time, and watched as home prices were in freefall in California (as in, if you didn’t reduce your asking price by $10,000 each week, no one would ever bid) but still held steady for the most part in NJ. When shopping for a home in late 2007/early 2008 in New Jersey, my wife and I were astounded by how much everyone expected their values to stay up. We managed to wait it out as the pressures continued to build, and closed on our new house–in August 2008, about a week before everything shut down.
(We’ve done fine, since, so no complaints here.)
Thursday ~ February 23rd, 2012 at 1:39 pm
Dave
@wrigglefreeabc– August 2007 was the start of the mortgage bond collapse and the start of the Libor rise, but it was slow at first. I worked at a hedge fund at the time– the idea that Something Was Amiss was definitely clear in August 2007 but I don’t think there was yet the common belief that it would kill a bank (a bunch of hedge funds, yeah…), at least among those of us who didn’t work in the interbank funding markets every day (perhaps this was clearer to those guys). By mid-fall 2007 though the signs in Libor were clear enough to catch the attention of those of us who weren’t directly involved in the money markets (I was a stock guy). And by December 2007 it was well-known that something was Really F***ing Wrong.
Thursday ~ February 23rd, 2012 at 1:49 pm
elboku
You were right? Really? All that happened is that the ones who took insane risks were rewarded. They pillaged everything and still do so. Look at the foreclosure mess. The rules of property law and contract law were broken by the banks and no one seems to care. Quite frankly, I don’t know why anyone should follow the rules; they don’t apply for everyone. Wealth accrued to the wealthy and the rest of us lived and worked to carry debt that was insane. Talk to me about how the economy is better when the median wage in America is 50k and not 27k as it is now. I still fail to see how the economy can get better when so few people have such little wealth. The vast, vast majority of Americans are 1 paycheck away from disaster.
Maybe the system collapsing might have led to a few heads rolling and people waking up to the horror that is our plutocracy. As it is now, it is the same ol’, same ol’.
Thursday ~ February 23rd, 2012 at 2:00 pm
Lord
What would you have liked them to do? Lend against or buy up their assets at face value and take the hit themselves? Put up enough money to cover their losses and merge them with other institutions? Provide debtor in possession financing? Promise that while they won’t save them or other investment banks they will make all their creditors whole? Say this far and no farther and save everyone going forward. They could have done anything they wanted but who could reasonably expect them to do so. There are no more important actions than those taken in crisis and their actions might have been different but what should they have been? They did not probably know themselves.
Thursday ~ February 23rd, 2012 at 9:03 pm
q
there are plenty of things that could have been to lehman’s book besides liquidating it haphazardly. most or all of them could have put taxpayer money at risk because they would have meant assuming liabilities as well as assets. of course it turns out that the amount that would have cost is a drop in the bucket compared with even the loss of tax revenue much less the lost gdp over the past N years.
Sunday ~ February 26th, 2012 at 5:07 am
Fred
I’m ready to give all my life savings and future salary to Goldman Sachs right now — where do I send it?
Friday ~ May 3rd, 2013 at 4:30 pm
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