Iceland and Lehman

The new book excerpt from  Hank Paulson points out that  the Lehman bailout deal fell apart at the last minute because of British government intransigence:

At 11 a.m., I went back upstairs, and soon got on the phone with (British Finance Minister) Alistair Darling, who wanted a report on Lehman. I told him we were stunned to learn that the FSA was refusing to approve the Barclays’ transaction

He made it clear, without a hint of apology in his voice, that there was no way Barclays would buy Lehman. He offered no specifics, other than to say that we were asking the British government to take on too big a risk, and he was not willing to have us unload our problems on the British taxpayer.

And who is Darling? The same smart guy who also used antiterrorist laws against Iceland when its banks collapsed.

Oct. 9 (Bloomberg) — Chancellor of the Exchequer Alistair Darling used anti-terrorism rules to take control of assets held in Britain by a troubled Icelandic bank.

Darling stepped in to protect deposits made by U.K. residents in Reykjavik-based Landsbanki Islands hf, which the government of Iceland seized yesterday. About 300,000 U.K. account holders held deposits at Landsbanki’s Internet bank, Icesave.

“To protect U.K. economic interests the government has frozen the funds and financial assets held by Landbanksi,” Stephen Timms, financial secretary to the Treasury, said in Parliament in London today

So basically, this crisis blew up because the British government was in self-preservation mode. This is not just a historical footnote….it suggests, as we already knew, that the fundamental weakness of the global economy is that there is no global central bank and no global regulators with real power.

Comments

  1. “this crisis blew up because the British government was in self-preservation mode”

    1) I thought capitalism was entirely about looking out for your own self-interest? Capitalism aside, that’s what countries do: do what’s in their own best-interest.

    2) They’re “not willing to have us unload our problems on the British taxpayer”? So what? That’s our problem. They don’t want it. Good for them. I wouldn’t have bought Lehman either.

  2. Whatever weaknesses there are, I don’t think I agree that a global agency could address them.

    You could say that the U.S. acted honorably in paying off AIG obligations to foreign banks, though that was not directly or obviously in the best interests of the U.S. If that hadn’t happened, then the calls for a global regulator would surely be much stronger. The U.K. remains in plenty of financial trouble. As best I can tell, it is of their own making, as much as is the U.S. crisis is of “our” own making. Same for many other crashed real estate markets — Spain, Ireland, etc.

    Global banking has been on a binge of risk taking. The U.K. and quite a few other nations were imitating the U.S. and drinking deeply from the trough. It is hard to imagine that a global regulator in that environment would have tightened up regulations or enforcement. If you’re suggesting that a global regulator would have stepped in to spread the pain evenly to avert a domino effect crisis, I think that we would never hear the end of unfairness claims and calls for their dismantling. As it is, the U.S. Fed can print dollars just as easily as a global regulator, so the currency didn’t plunge and we see that there is more to global stability than monetary policy, be it central or distributed.

    On the other hand, it is nice to dream of global currency police that prevent valuation abuse.

  3. You retail two common fallacies about the financial crisis, that the Lehman collapse precipitated it and that regulators could have somehow averted the crisis. Markets were fairly stable after the Lehman collapse, it is only a week later, after Paulson and Bernanke started crying wolf, that the stock market plunged, as John Taylor has pointed out. As for your fantasy that regulators would somehow solve all these problems given greater authority, we already have a great test case for that theory, OFHEO, which had the easy task of regulating only two companies, Fannie and Freddie. Those two companies are now estimated to have losses of $400 billion or more, dwarfing all other bailout losses combined from AIG, et al, despite being highly “regulated”. During the runup and into 2007 and 2008 when signs of a collapse were looming, Fannie and Freddie were buying up or insuring mortgage securities and were pushed into doing more by congressmen like Barney Frank.

    The only workable “regulation” is market competition and oversight, where investors enforce discipline in such firms by pulling out their money. However, there’s no incentive for creditors to do so if they know the govt can always be called on to intervene with a sob story and bail them out, as Russ Roberts has pointed out (some interesting congressional testimony for once in the mp3 at that link). As I’ve mentioned before, I know someone who tried to get their investment firm to hedge against a possible Lehman collapse but he was outvoted by the rest of his partners because they felt the govt would step in at worst. If even on the edge of calamity they felt that secure of govt intervention, imagine how lazily they think about these investments when times are good! I should add that I do think the current crisis was unprecedented in some ways because of how new financial innovation like derivatives and rules like mark to market combined in unexpected ways to exacerbate the crisis.

    However, given how much of that innovation was designed to sidestep existing regulation- such as constructing mortgage-backed securities to have a AAA rating because of regulations that only allow pension funds to invest in such high ratings- and how regulators were completely unaware of those risks, even when the world’s richest investor warned in 2002 that he was getting out of the market because of those risks, your and others’ delusions that regulators will somehow get it right the next time around are laughable. At least when creditors make mistakes and don’t get bailed out, they lose their money and learn. When govt and regulators make even bigger mistakes, they get more funding and Barney Frank keeps on going with even more power because credulous voters and writers such as yourself hope they’ll get it right next time, in the face of a stack of evidence that they can’t and won’t.

  4. I’ve gotta go with the free-market guys on this one: building a bigger umbrella only puts all of our eggs in one basket rather than distributing risk.

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