5 lessons of the Great Recession
Five years after the worst crisis since the 1930s, America has devised safeguards and changed the rules of Wall Street. But could the country really avoid another financial collapse?
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Underscoring that "too big to fail" may be passé, the FDIC has been doing "road shows" with a simple message for bond investors, whom it sees as central to curbing excessive risk: Next time around, the government won't rescue you. Dodd-Frank, meanwhile, tells big financial firms to have "funeral plans" ready in advance. Back in 2008, nothing like this dissolution authority existed. Instead, uncertainty roiled markets as investors saw some firms getting government help while others suffered fatal losses.Skip to next paragraph
Given the dire repercussions, some economists say the real question isn't why some firms received bailouts but why Lehman didn't. Bernanke later told a bankruptcy examiner that the firm simply didn't have enough value or assets left to secure any government loan. The Fed and Treasury had no authority to step in. "I speak for myself, and I think I can speak for others, that at no time did we say, 'We could save Lehman, but we won't,' " he said.
Others say the bailouts went too far, even allowing for the need to quell a post-Lehman panic. Sheila Bair, who chaired the FDIC at the time, remembers pushing for a harder line on the troubled banking giant Citigroup.
She urged that regulators at least consider putting the commercial bank portion of the company into FDIC receivership, as occurs with other failed banks. At a minimum, she hoped the government could set up a "bad bank" and force Citi to sell some of its toxic assets.
"We learned this during the Savings and Loan crisis," says Ms. Bair. "Ripping the band-aid off, forcing banks to shed their bad assets, to take their losses, getting them out there lending again – that would generally be much better to support the economy than just propping them up."
In her view, the crisis could still have been stanched, and the economy would be stronger today, if her approach had been tried.
But in early 2009, with the country shedding jobs, the Treasury's overriding goal was emergency support for the financial system – Citi included. The former senior member of the Obama administration says the path to a stronger economy lay in greater fiscal stimulus, not a different approach to mending banks.
"If you look at how our financial system has performed relative to any other major economy caught up in this mess, we went very quickly to a financial system that was able to lend again and support a growing economy," the official says.
To date, most "bailout" money extended by the government has been paid back, but a handful of firms (Fannie Mae, Freddie Mac, the lender GMAC, and General Motors) still owe some $85 billion collectively, according to the investigative website Pro Publica.
One factor that may lessen the need for bailouts in the future is simple prevention. In the end, the biggest problem that got financial firms into trouble was too much leverage – too many loans or investments relative to their capital reserve.
Now, via both Dodd-Frank and evolving global standards, major banking firms are being asked to have less leverage. It's a point both Paulson and Bair view as crucial.
"Very importantly, there are stronger capital and liquidity requirements," Paulson says. "That's the best defense against failure."
4. WHAT HAPPENS IN AMERICA DOESN'T STAY IN AMERICA.
On Sept. 14, 2007, people in Britain lined up at branches of the Northern Rock bank, desperate to withdraw their savings. It looked like a classic bank run, with people in shirt sleeves carrying satchels. That morning the Bank of England had to swoop in to give the institution emergency funding.