Financial Times Editorial Comment: The legacy of Lehman Brothers

Financial Times Editorial Comment: The legacy of Lehman Brothers
Copyright The Financial Times Limited 2009
Published: September 13 2009 19:34 | Last updated: September 13 2009 19:34
http://www.ft.com/cms/s/0/e534e69c-a091-11de-b9ef-00144feabdc0.html


One year ago, the US authorities allowed Lehman Brothers to collapse, unleashing chaos. Capital markets froze, banks stumbled and a cascade of collapses seemed imminent. The financial system was seized with fear. A high-speed repeat of the American banking crisis that underpinned the unique misery of the 1930s threatened.

The US authorities were, however, right to allow Lehman Brothers to fail. They could not know how awful it would prove to be, and, when it comes to saving failing companies, governments should err on the side of inaction. Capitalism relies on the discipline provided by the lure of wealth and the fear of bankruptcy.

Indeed, the objective of policy must now be to make sure that, the next time that a major bank founders, there is no need for governments to step in and save other institutions, as they had to do in the aftermath of the Lehman collapse, when they fought to avert a second Great Depression.

So bankruptcy regimes for banks must be improved. Combined with “living wills” for banks and pushing derivatives on to exchanges, such measures should reduce the chances of a repeat of the severe uncertainty that emerged in the frenzy of last autumn.

There also needs to be systemic regulation to prevent too many financial institutions from sharing the same vulnerabilities, and from posing avoidable risks to the institutions trading around them.

In Europe and in the US, there is a consensus about the need for such oversight. But this agreement has quickly turned into an argument about which institution should be the super-regulator, and whether such responsibilities can be split. This can wait.

It is more important to decide what regulation is supposed to do. There needs to be political debate about whether regulators should target asset price inflation by varying capital requirements, or simply fortify the banks against crashes. There should be public discussion about whether it is better to make big banks failsafe with thicker capital buffers or force them to slim down so that when they do fail, they fail safely.

Policymakers must own up to the fact that there are some institutions they can never credibly claim they will let fail. They must identify who they are implicitly backstopping so they can charge a fee for that insurance. Vague talk of systemic regulation and higher capital ratios is not enough. Politicians need a strategy for making finance safer, and soon. Who does what is a question for later.