Sep 15, 2008

Lehman collapses, how will the financial system react?

After rumours spreading over the weekend, Lehman Brothers filed for Chapter 11, which means, the company will attempt to re-organize its debt obligations under supervision of a bankruptcy court. The hot debate circulating now in the blogosphere is, will this imply the beginning of a generilized collapse?

Nouriel Roubini seems to think so. On September 13 he wrote:
"If Lehman does not find a buyer over the weekend and the counterparties of Lehman withdraw their credit lines on Monday (as they all will in the absence of a deal) you will have not only a collapse of Lehman but also the beginning of a run on the other independent broker dealers (Merrill Lynch first but also in sequence Goldman Sachs and Morgan Stanley and possibly even those broker dealers that are part of a larger commercial bank, I.e. JP Morgan and Citigroup). Then this run would lead to a massive systemic meltdown of the financial system."
There is a reason to believe the consequences associated to Lehman Brothers' (LB) bankruptcy are not so dire. This should be why the US government did not intervene in LB's rescue. As reported by Ken Houghton at angrybear, while in the case of Bear Sterns (BS) the rescue was necessary becuse the bank had clearing business (too interconnected to fail), LB had none. Had BS failed, many financial firms would have been unable in the next days to run their current transactions (of several billion $ in size). In the case of LB, those operations were part of the current business and as such under the control of "risk managers" (I know this sentence sounds like an oxymoron but that's how the finance industry reasons today) and priced into market instruments. So, the "shadow banking" system may survive, but we may face some other firms going out of business and thousands of job losses along the way: a deeper recession.

[Update: Another interesting view about LB's bankruptcy is offered by Willem Buiter.]

1 comment:

Pierre-Louis said...

Merryl Lynch was just bought by Bank of America! there is so much restructuing of the investment banking industry it's crazy. It's alos amazing at what point the economy is not that much affected (so far) by the complete wall street crisis!!! our world keeps turning!