What if Lehman had been Bailed Out?
By Arnold Kling
In truth, a Merrill or A.I.G. default would have created something akin to a financial nuclear bomb — much worse than Lehman’s filing for bankruptcy. Merrill was a much bigger firm, with deep roots on Main Street thanks to its “thundering herd.” A.I.G. was the world’s largest insurance company, whose credit-default swaps were propping up half of Europe’s banks. (By buying A.I.G.’s swaps, European banks could evade their capital requirements.) Lehman, by contrast, was a smaller firm, with practically no ties to Main Street. The risks it posed to the system were real — but smaller.
Almost everyone I’ve ever spoken to in Hank Paulson’s old Treasury Department agrees that without the immediate panic caused by the Lehman default, the government would never have agreed to make the loans needed to save A.I.G., a company it knew very little about. In effect, the Lehman bankruptcy caused the government to panic, which in turn caused it to save the firm it really had to save to prevent catastrophe.
Pointer from Tyler Cowen. I am not ready to revise my view that the bailouts served special interests and were not necessary to keep ordinary financial operations running.