9/15 is another date we should never forget

A year after the needless collapse of Lehman, capitalism has survived. But the aftershocks will be felt for a long time

This week, as you may have noticed on Monday, but had probably forgotten by this morning, was the first anniversary of the collapse of Lehman Brothers.

For Rip Van Winkles who look at their finances only once a year and note that stockmarkets, house prices and currencies are today pretty much where they were a year ago, Lehman was a second-tier Wall Street investment bank that went bankrupt on September 15 2008: 9/15 is not ingrained in our memories like 9/11 but it triggered what was briefly the biggest financial crisis in history and inspired widespread prophecies of a 1930s-style Great Depression and the end of the capitalist world as we know it. We now know that the sky did not fall in as the Chicken Little commentators predicted, but does this mean that all the fuss was just a storm in a teacup?

The answer is no. As a result of Lehman’s bankruptcy, millions of people have needlessly lost their jobs, hundreds of thousands of homes have been needlessly repossessed and trillions of dollars, pounds and euros have been needlessly added to the debt burdens of governments around the world. I repeat that word needlessly because most of these losses would not have happened if Lehman had been supported or wound down in an orderly way.

The chaotic collapse of Lehman was the heart attack that turned a serious, but manageable, ailment in the world of finance and the housing markets into a near-death experience for the real economy of industry and jobs. In short, the world changed with Lehman.

Anyone who believes that stabilising Lehman was financially or politically impossible should note that the US Treasury bailed out the insurance group AIG at far greater public expense 24 hours later, when AIG’s potential failure threatened the survival of J.P. Morgan and Goldman Sachs. Had it not been for this rescue and the unlimited guarantees offered by governments to every significant financial institution the world over, the sky really would have fallen in.

The US Government’s decision to let Lehman go bankrupt will go down in history as one of the greatest public policy mistakes made. This unforced error proved even more costly to the Bush Administration than its blunders in Iraq, Afghanistan and New Orleans.

Conversely, the rapid improvement in economic policymaking and financial conditions once a new administration took office amply justifies my claim that Henry Paulson, the US Treasury Secretary, was to finance what Donald Rumsfeld was to military strategy.

The clearest lesson of the Lehman debacle, therefore, is that sound leadership is as vital in economic crises as it is in wars. This may seem a simplistic platitude in comparison with the sophisticated analyses of moral hazard, global imbalances and monetary objectives offered by other commentators. But I believe that the main long-term impact of Lehman will be to remind the world of the symbiosis between markets and political ideologies. And this recognition will encourage the emergence of a new phase of global capitalism to replace the market fundamentalism inaugurated by Margaret Thatcher 30 years ago. What might this new thinking entail?

First, that a market economy requires active government. This is now obvious in the financial sector, whose survival always depends ultimately on government guarantees. The only alternative to guaranteeing all bank deposits and interbank transactions would be to revert to the world of mortgage queues, credit rationing and foreign exchange controls. But limitless government guarantees mean that banks will face more intrusive scrutiny from regulators who will be bolder than in the past.

A second controversial function of government has been reinforced even more by the crisis: active demand management. This boom-bust cycle has demonstrated conclusively that monetary and fiscal demand management works and is necessary. Conversely, the post-Lehman experience has refuted the unrealistic theory that markets behave rationally and which purported to show that demand management was ineffective and which dominated university economics for almost 20 years.

This small earthquake in academic economics may seem arcane, but the demise of this theory points to a third aspect of post-Lehman thinking with huge political implications. By discrediting the dogma of rational markets, the financial crisis has reopened ethical debates on issues such as executive earnings, income distribution and environmental subsidies that were previously closed down simply by invoking market forces to legitimise the status quo.

Governments will also have to take responsibility for micro-economic decisions such as regulating speculation in mortgages and oil that they previously dodged simply by asserting that prices reflected the realities of supply and demand.

But surely Lehman showed that governments make disastrous mistakes at least as often as financial markets? And surely the post-Lehman collapse in tax revenues proves that governments need banks as much as banks need governments? The symbiotic relationships between imperfect markets and imperfect governments leads to the fourth and most fundamental lesson of the crisis: everyone now understands that economic events are inherently unpredictable — and this implies that both markets and politicians are prone to error. Recognising this inherent fallibility should not be paralysing, but empowering.

The virtue of competitive markets is to correct small misjudgments fairly quickly. In politics, democratic competition plays a similar error-correcting role. But when herd instinct overtakes investors, markets magnify errors instead. The same happens in democracies when one ideology overwhelms all debate.

In a fast-moving, interdependent and unpredictable world, scepticism, experimentation and flexibility are crucial. Ideological flexibility and the recognition of errors should be seen as a cardinal virtue in politicians and central bankers, as well as in businessmen and financiers.

If the world can absorb these lessons and evolve new relationships between government, business and finance, then the redesigns of monetary policy, regulation and economic theory will naturally follow. The bolt from the blue that was Lehman wiped out the market fundamentalism of Mrs Thatcher and Ronald Reagan. Intellectual evolution must now create a new species of capitalism to bestride the post-crisis world. (Anatole Kaletsky, The Times) http://www.timesonline.co.uk/tol/comment/columnists/anatole_kaletsky/article6839039.ece

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