Howard Davies: Thoughts on a weird week

The US Treasury, and the Federal Reserve, have made some tough calls. How well have they done?

Last Updated: 31 Aug 2010

In the US, they face many virulent critics. Some argue that they have been too interventionist, rescuing feckless banks from the consequences of their follies and creating moral hazard in the process.  Why should the shareholders of Bear Stearns, hardly a systemic firm, have benefited from a sweetheart deal with JP Morgan facilitated by the Fed? What business does the Administration have nationalising (conservatorship? - come off it) Fannie and Freddie, creating a huge potential liability for the taxpayer?

From the other corner, on Wall Street, come mirror-image complaints. The Fed is out of touch. It has been slow to understand the crisis. Letting Lehman go to the wall was unnecessary and unwise.  AIG was left twisting in the wind for too long, creating market panic, even though it was eventually taken over. Are the political critics right, or do the feckless bankers have the better of the argument? Or neither?

My instincts, as a former regulator, lie with the authorities. They didn't dream up this crisis in Washington, though the Greenspan Fed may have to shoulder part of the blame when the post mortem is complete. (Only in London do politicians seem to think the regulators and central banks are mainly at fault). And sometimes, when the house is ablaze, you need to put out the fire first, and worry about moral hazard later. But there is a worrying lack of consistency in the responses to date.

Why was Bear Stearns helped into the arms of JP Morgan, while Lehman was let go? Can one really distinguish between them, either on systemic grounds or on the basis that Lehman were more responsible for their own demise? It seems more likely that the reason for the different treatment is simply that in the aftermath of the Fannie and Freddie rescue, which caused a political storm and in the knowledge of the AIG crisis, the Treasury could not contemplate yet another rescue which put public funds at risk.

When it comes to the mortgage banks it is worrying that it took the Administration so long to realise that they were holed below the waterline. The markets in New York and in London - in a more nervous condition than we have seen for decades - depend heavily on confidence in the US Treasury and the Fed. That confidence has taken a knock in recent weeks. We must all hope it is soon re-established.

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