The right questions

by Russ Roberts on March 16, 2009

in Financial Markets

James Freeman at the WSJ asks the right questions about the Bear Stearns crisis a year ago. Was the government's role, that began the move down the slippery slope of bailing almost everyone out, really necessary? Did it make things better or worse? An excerpt:

One could argue that the Bear bailout not only didn't prevent the
failure of Lehman and AIG six months later, but it may have contributed
to the autumn meltdown. If nature had been allowed to take its course,
Bear's directors and executives would have faced the liability tsunami
of bankruptcy, and creditors would likely have suffered as well.
Watching this horror show, would the leadership at AIG and Lehman have
spent more of the next six months seeking to avoid this fate?

Bear stockholders ended up receiving $10 for each of their shares.
Responding rationally to this government intervention, and knowing that
their firms were each significantly larger than Bear, executives at AIG
and Lehman might have believed that the feds had just built a floor
under them.

Come the reckoning in September, Lehman CEO Richard Fuld was stunned
to discover that Washington was willing to see his firm go bankrupt.
Given how little value was left at Lehman's bankruptcy, perhaps it
would have failed in any case. But false expectations created by
Washington didn't help the firm's decision makers.


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