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The Confidence Game.

CAMBRIDGE – Next month marks the one year anniversary of the collapse of the venerable American investment bank, Lehman Brothers.  The fall of Lehman marked the onset of a global recession and financial crisis the likes of which the world has not seen since the Great Depression of the 1930’s. After one year, trillions of dollars in public monies, and much soul searching in the world’s policy community, have we learned the right lessons?  I fear not.

The overwhelming consensus in the policy community is that if only the government had bailed out Lehman, the whole thing would have been a hiccup and not a heart attack.  Famous investors and leading policymakers alike have opined that in our ultra-interconnected global economy, a big financial institution like Lehman can never be allowed to fail. No matter how badly it mismanages its business – Lehman essentially transformed itself into a real estate holding company totally dependent on a continuing US housing bubble – the creditors of a big financial institution should always get repaid.  Otherwise, confidence in the system will be undermined, and chaos will break loose.