Will Lehman be the last?

September 13, 2008

The media concentrates on the demise of Lehman, but whatever befalls this institution is not of great consequence anymore. It’s almost a certainty that all the major financial actors have already made their preparations for any contingencies that will arise from this issue, and apart from the usual sell-off or rally to occur on Monday, nobody should hold his breath about the decorations of Lehman Brothers’ shroud.

The real issue here is the aftermath of this event. The half-hearted measures of the government are unlikely to instill much confidence in the markets, nor is it realistic to expect the Fed or the Treasury to have any success in reducing this very large body of continuing losses. As long as fear and pessimism persist, people will keep speculating on who will be the next to fall, increasing risk spreads and premiums, and eventually creating more bank failures, more bankruptcies, more defaults, and so forth. There’s already speculation about the fate of Merril Lynch, and there’s no reason to think that Lehman will be the last to die among the large institutions. Indeed, as long as the rumour mill is turning, as long as there’s a scarcity of goodwill, and as people realise that solvency issues are behind today’s difficulties, it’s a certainty that other institutions will fall too.

Just like the happy bubbles of yesterday fed on themselves to create ever more euphoria, the negative bubbles of today and tomorrow have the power to feed on panic and fear and reach irrational sizes. The only way to stop this from occurring without ruining the global financial system is global action by the central banks of the world, arguably nationalization and dismantling of bankrupt institutions. Essentially, there’s a need to create a central pool among central banks and treasuries to deal with the contingencies that are arising day after day. Because if this is not done, fiscal constraints, and political problems will prevent the actualisation of the very radical measures that are needed: in essence, the dismantling of the failing institutions, and socialisation of their losses. Of course it’s very unpleasant to even discuss this prospect, but what must be understood is that the failure and self-destruction of the financial system will hurt every single nation and individual in the world. There’s no way to escape the consequences of the debt binge of the past decade. And that bubble was a universal phenomenon, it inflated everything, now it will deflate everything.

The worst that can be done right now is an attempt at perpetuating the crisis by refusing to recognise the paradigm shift that has happened. To try to goad the US consumer to spend like he did in the past by stuffing ever more money into his pockets is only a way of delaying the inevitable for a few months. The positive effect of the latest stimulus package apparently lasted for only two months, indeed a very disheartening outcome for those who were expecting this to sustain consumption as during the 2001 recession. Today, however, people know that the era of non-stop borrowing is over, and just a single glance at the foreclosed homes of neighbours is enough to make them reconsider their plans of spending as if they had printing presses in the living room.

The growth potential of the US is less than what it was during the last decade. This is a fact that everyone has to realise. But of course, before that, we must first do our best to prevent the recession from turning into a depression: most reasonable people would now probably admit the clear potential for such an outcome.

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