When the US Federal Reserve decided, a year ago, not to save Lehman Brothers, it did so mainly on the principle that governments should never interfere with the financial markets. After two decades of progressive deregulation, the high priests of capitalism believed it was time to draw a line in the sand. Since neoliberalism’s ascendancy in the Reagan years, a dogmatic faith in the magic of untrammelled market forces had encouraged breath-taking levels of risk by Wall Street’s “masters of the universe,” much of it with capital that was leveraged to unprecedented levels. (When Lehman’s went under it held investments worth more than 40 times the bank’s available funds.) This meant that when the fallout from the housing bubble could no longer be hidden by clever accounting, brutal market corrections were all but inevitable.
Once the public got wind of the scale of Lehman’s debts it began to lose money at a terrifying rate. At the height of the crisis the bank was losing US$8 million each minute. When it filed for bankruptcy on September 15, Lehman’s reported losses ten times larger than Enron’s and left 28,000 staff around the world jobless overnight. The shockwaves were immediate. The Dow Jones lost 500 points in a single day, and the resulting chaos wiped an estimated US$70 billion off the markets. It soon became clear that the entire US financial system was under threat. When the mortgage giant Washington Mutual went under ten days later, even the most sober and experienced bankers began to believe that a financial Armageddon was imminent. The confusion of these times was captured in one of President Bush’s most memorable lines as he explained that he had “abandoned free market principles to save the free market system.”
Lehman’s default set in motion a domino effect that the Fed’s sages had recklessly ignored. As a host of other banks inherited the Lehman debts, several were strained to breaking point. As the crisis spread further afield it undermined the entire credit system. Starved of credit, without any warning, many large American companies were in danger of not making payroll, forcing the government to intervene and provide loan guarantees to arrest the cascading debt.
The sudden disappearance of Lehman Brothers was also momentous because it destroyed the myth that US banks could escape the consequences of their foolish investments. For most of the nineties, the idea that risk could be eliminated from a system, or at least passed harmlessly on to other people, was a central tenet of Wall Street’s faith in its own powers. When it turned out that the arcana of credit default swaps and securitised mortgages only disguised risk, and that the epidemic of mortgage defaults was exposing the whole system as a house of cards, it was too late to undo the staggering gambles which some of the country’s most prestigious financial institutions had undertaken.
After dragging its heels for weeks, the US government was forced to accept that the worst case scenario – complete systemic failure – might soon come to pass, unless it acted decisively. When panic extended to the global credit system it also became clear that this crisis would have to be handled multilaterally and that without a substantial alteration of the previous free-market philosophy the gathering financial crisis – which we have yet to emerge from, a year later – could easily have been made significantly worse. Even when it did act, the major economic powers could only do so much. Massive losses spread to every corner of the global financial system, as clients of Stanford bank and Clico know to their cost.
In retrospect, it is painfully ironic that many analysts believe Lehman’s could have been saved for the relatively cheap sum of US$20 billion. Barclays Bank was on the verge of a deal that would have kept the bank alive, but pulled out when the US government refused to secure Lehman’s debts. Instead, a small group of free-market ideologues were allowed to set in motion a global financial tsunami for principles that they abandoned only a few weeks later. One year later, even after the gigantic federal stimulus packages and trillions of dollars worth of deals to encourage Wall Street to purchase ‘toxic assets’ the US economy is in poor shape. Official unemployment is close to 10 per cent; more than 1.5 million mortgages were foreclosed during the first seven months of this 2009 and by June almost one in every three mortgage holders were estimated to owe more than the value of their home. Goldman Sachs estimated that the first five years of this crisis are likely to result in 13 million foreclosures. Worse yet, many of Wall Street’s most notorious risk takers and overcompensated executives, have been gifted huge sums of money to clear up the mess they created. Most damning of all, perhaps, is the complete absence of dedicated legislation to prevent the excesses which led to the crisis in the first place. Wall Street may have helped avoid the worst case scenario, but unless the US government discards the idea that markets can be left to take care of themselves, it is only a question of time before it’s déjà vu all over again.
