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Paulson boldly moves to clean up system
After a year of grim financial news, it would be easy to dismiss the collapse of Lehman Brothers as just another bad day at the office. Easy, but wrong.
- By Jeff Randall, The Daily Telegraph
- Published: 23:42 September 19, 2008
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London: After a year of grim financial news, it would be easy to dismiss the collapse of Lehman Brothers as just another bad day at the office. Easy, but wrong.
This is a rare defining moment, when regulators call the bluff of those who say that the demise of such an important bank will ruin our economic infrastructure. It is the day of reckoning.
In throwing Lehman to the dogs, US Treasury Secretary Hank Paulson is betting heavily that dire warnings of "contagion", "systemic risk" and "domino effect" are little more than special pleading from hitherto Masters of the Universe who would like the taxpayer to save their over-priced skins. It is quite a punt.
Soon enough we will discover if the core of Western finance is just an elaborate Ponzi scheme, underpinned only by new waves of suckers, or an imperfect but flexible machinery that, despite its flaws, has the capacity to withstand shocks. Either way, it seems to me, Paulson was right to turn off the tap. If the system is rotten, why shore it up? If it's not, then it will - somehow - survive without more state aid.
The next test may not be far away. Right behind Lehman, in the departure lounge of life, is AIG, the giant insurance group, that lost $18.5 billion in the first nine months of this year. Last week, the insurance regulator threw it a lifeline, but it remains on the critical list.
Lehman got what it deserved: to be the test case for a Darwinian shake-out. I fail to see why garbage collectors in Gloomsville should pay taxes so that $1,000-an-hour bankers can retain their seats at the Wall Street casino. They had their fun and they lost their chips. Correction, they lost other people's chips.
All right, so directors' share options are no longer worth anything, but all those jackpot bonuses have long since been banked - and they're not coming back. Lehman provides the latest egregious example of reward for failure.
What little faith I had in financial wizardry was blown away 10 years ago when Long Term Capital Management, a hedge fund set up by a couple of economists with Nobel Prizes in the cupboard, went pop. Lehman, I'm afraid, went the same way: bamboozling itself. Over lunch at its Canary Wharf offices, you could feel the heat from all those first-class brains, working out how to make billions from financial products that only an expert in nuclear fusion could comprehend. I didn't have a clue what they were talking about. The trouble is, it turns out, neither did they.
As a former Goldman Sachs executive, Paulson understands that the unravelling of Lehman is not a sign, per se, that free markets are failing. Quite the reverse. They work best when driving out weak and inefficient operators. Creation and destruction are part of the game. Sending a message that all sinners will be saved only encourages reckless behaviour.
Meddling politicians often find this impossible to accept. They would rather pay a stricken company's ransom than face the wrath of voters whose interests are linked to a business that is about to go bust.
Fannie Mae and Freddie Mac were special cases. Not because they are inextricably linked to the US housing market - although that is certainly true ($5.4 trillion of liabilities) - but because from the outset they were "government-sponsored" private companies. As quasi state bodies, their implicit guarantee was that Washington stood behind them. Had they gone under, it would have told the world that Uncle Sam was happy to renege on his promises.
While unbothered by the wiping out of shareholders in Fannie and Freddie, the US Treasury was determined to preserve value for their bondholders.
The reason was that these bonds are held in vast quantities by foreign governments, notably China's, whose confidence Washington is desperate not to lose. With more than $1 trillion of foreign-exchange reserves, China is equally anxious that America's economy, and with it the dollar, does not get flushed away.
As the world's buyer of last resort, the American shopper is exhausted. Having drained all credit, he can barely keep up with mortgage payments and is scared stiff that his job is about to be axed.
The world's locomotive of consumption is leaking oil. Not since the Wall Street Crash of nearly 80 years ago has the financial system that supports Joe Sixpack's lifestyle been so severely stretched. Lehman has gone, others seem sure to follow. There will be no quick fix.
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