Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.
Now that we’re injecting Federal equity investment into the broad spectrum of the US banking industry, the notion that a little help for Lehman at the critical moment was an unacceptable “moral hazard” seems a bit quaint. Of course, there would have been other shoes that dropped, most notably AIG, but without the spectre of sheer terror that enveloped the global “unsecured creditor of troubled financial institution” market that erupted as Lehman went under, and put global credit markets in the meat locker.
And why was it unacceptable for Lehman to convert to a bank holding company but a couple weeks later OK for Morgan Stanley and Goldman Sachs to grab that lifeline? While none of these institutions has a particularly sympathetic aspect in terms of their own involvement in getting us into the mess we are in, this discrimination in terms of access to the Fed seems like a bit of “selective socialism” (which is, of course, a contradiction in terms).
Now of course we can’t bring back Lehman, but there is a need to rethink the premises on which Lehman was allowed to fail even though it was just as pivotal in global finance as was Bear Stearns, whose creditors were given a Fed-insured gift certificate cashable at JP Morgan.
It may be safe to say that Lehman will be the last example for a while where ‘”moral hazard” trumps “systemic hazard” — otherwise, the folks running our Fed Reserve and Treasury just plain misunderstood the extend of systemic risk posed by a Lehman bankruptcy — they’re not supposed to get that sort of thing so terribly wrong, so let’s assume for the sake of our own sanity that they just were standing on principle.
Where to from here? It all goes back to housing finance — how, and in what form, do we recreate a securitization market for mortgage debt where: (1) the originator retains enough of a stake in the outcome to assure prudent risk assessment; (2) rating agencies are vaccinated by appropriate compensation arrangments from the virus of blatant conflict of interest in terms of their own prudent judgment (ie, they should not continue to be compensated only if they grant the ratings requested); and (3) default insurance written against collateralized debt instruments is properly reserved against and transparently cleared.
More simply put, it is time for the end of “non-bank” banks; “non-insurance” insurance; and that greatest of all self-contradictions, “self-regulation”. Character, indeed, is what you are in the dark — which is why some folks get the reputation as “shady”. Character will out, but considering the price we are all now paying for what went on in the dark rooms of finance, perhaps that old Socialist Ronald Reagan had it right with his maxim, ”Trust but Verify”. At least that seems the best way to avoid being forced to choose between “moral hazard” and ruination.
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