Page 511 - untitled

482 Dissenting Statement

fl ee the PMBS market, reducing the liquidity of the fi nancial institutions that held
the PMBS; and (v) mark-to-market accounting required these institutions to write
down the value of the PMBS they held, as well as their other mortgage-related assets,
reducing their capital positions and raising further questions about their stability
and solvency.

Government Actions Create a Panic
More than any other phenomenon, the fi nancial crisis of 2008 resembles
an old-fashioned investor and creditor panic. In the classic study, Manias, Panics
and Crashes: A History of Financial Crises, Charles Kindleberger and Robert Aliber
make a distinction between a remote cause and a proximate cause of a panic: “Causa
remota of any crisis is the expansion of credit and speculation, while causa proxima
is some incident that saps the confi dence of the system and induces investors to sell
commodities, stocks, real estate, bills of exchange, or promissory notes and increase
58
their money holdings.” In the great fi nancial panic of 2008, it is reasonably clear
that the remote cause was the build-up of NTMs in the fi nancial system, primarily—
as I have shown in this analysis—as a result of government housing policy. Th is
unprecedented increase in weak and risky assets set the fi nancial system up for
a crisis of some kind. Th e event that turned a potential crisis into a full-fl edged
panic—the proximate cause of the panic—was also the government’s action: the
rescue of Bear Stearns in March 2008 and the subsequent failure to rescue Lehman
Brothers six months later. In terms of its ultimate cost to the public, this was one of
the great policy errors of all time, and the reasons for the misjudgments that led to
it have not yet been fully explored.
Th e lesson taught by the rescue of Bear was that all large fi nancial
institutions—and especially those larger than Bear—would be rescued. Th e moral
hazard introduced by this one act irreparably changed the position of Lehman
Brothers and every other large fi rm in the world’s fi nancial system. From that time
forward, (i) the critical need for more capital became less critical; the likelihood of
a government bailout would reassure creditors, so there was no need to dilute the
shareholders any further by raising additional capital; (ii) fi rms such as Lehman,
that might have been saved through an acquisition by a larger fi rm or an infusion of
fresh capital by a strategic investor, drove harder bargains with potential acquirers;
(iii) the potential acquirers themselves waited for the U.S. government to pick up
some of the cost, as it had with Bear—an off er that never came in Lehman’s case;
and (iv) the Reserve Fund, a money market mutual fund, apparently assuming
that Lehman would be rescued, decided not to sell the heavily discounted Lehman
commercial paper it held; instead, with devastating results for the money market
fund industry, it waited to be bailed out on the assumption that Lehman would be
saved.
But Lehman was not saved, and its creditors were not bailed out. At a time
when large mark-to-market losses among U.S. fi nancial fi rms raised questions about
which large fi nancial institutions were insolvent or unstable, the demise of Lehman
was a major shock. It overturned all the rational expectations about government

58 Charles P. Kindleberger and Robert Aliber, Manias, Panics, and Crashes: A History of Financial Crises,
5th edition, John Wiley & Sons, Inc., 2005, p.104.