Tuesday, October 18, 2011

The Euro Crisis: Lessons From Bear Stearns

by David Skeel

Wall Street Journal

October 18, 2011

Ask a European official to sum up the euro-zone crisis, and you are almost certain to hear the "L" word. German Chancellor Angela Merkel recently warned that a Greek default could be Europe's Lehman, triggering a world-wide market crisis.

A Google search of Greece and Lehman Brothers now yields over five million hits. There are indeed frightening similarities between the euro-zone crisis and the 2008 market meltdown in the U.S., but Ms. Merkel and the conventional wisdom have pinned their tail on the wrong donkey.

Start with the analogy between Europe and Lehman. According to the conventional wisdom, failing to bail out Lehman in September 2008 was the U.S. government's biggest mistake in the crisis. Having watched the damage unleashed by Lehman, the reasoning goes, we now know that regulators must stand ready to step in with rescue funding. This conventional wisdom completely misinterprets the significance of Lehman.

The real misstep came six months earlier, when the U.S. government was faced with the decision to bail out Bear Stearns or let it file for bankruptcy. By opting for a bailout, the government signaled that it would bail out any of the largest financial institutions if they threatened to fail. Heeding this message, Lehman failed to take the tough measures it needed or to make any serious plans for its eventual bankruptcy.

Like everyone else, Lehman's managers assumed that the government would come to the rescue. If Bear Stearns hadn't been bailed out, everything would have been different.

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