Professor Elam

Tuesday Oct 18, 2011

On page A 17 in today's WSJ, David Skeel, a University  of PA las professor, argues that bailing out Bear Stearns was the big mistake in 2008. That sent the wrong message to Lehman, which failed to clean up its balance sheet.  

I would argue that it was way too late by 2008 to start sending messages. The mistake was the 1998 bailout of Long Term Capital Management by Greenspan and company. LTCM was a relatively small player compared to what happened in 2008. But as the Time Magazine cover said, Three Who Saved the World (Greenspan, Rubin, Summers) that was the wrong message. If LTCM had been allowed to fail, the message would be that one can go broke. And the message to buyers of such risky derivatives would be, caveat emptor, you are on your own. 

And so Merrill Lehman Bear et al piled on leveraged debt to buy risky mortgages. All had become public companies so the partners weren't at risk, the shareholders were. And of course they all went to the government begging for a bail out when things blew up. 

At any rate, I do agree with Mr. Skeel, that letting Greece and its bondholders fail would send the only successful message to Spain and Italy, fix it.