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Unfortunate, but Necessary

Posted By Conn Carroll On September 15, 2008 @ 1:45 pm In Ongoing Priorities | Comments Disabled

Heritage scholars JD Foster and David John react to this weekend’s Wall Street turmoil:

While unfortunate for both Lehman and Merrill Lynch, what is most important about these transactions is that markets are in one important sense returning to a normal order even in the face of uncertainty and turmoil: One firm filed for bankruptcy; another is sold; no direct government financial involvement.

Other points from the Heritage domestic policy team:

  1. In our economic system, failed firms go bankrupt. It’s unfortunate, but necessary to future prosperity. In our system, firms are bought and sold as conditions warrant or necessitate. This, too, is normal and necessary for prosperity.
  2. What should not happen, except in truly extraordinary circumstances of dire systemic risk, is for taxpayers to be asked to bailout those who have made mistakes. The difference between Lehman and Bear Stearns is the potential for a market collapse. Bear failed at a time of high anxiety when severe market over-reaction was likely. In the cases of Lehman and Merrill, no bailout occurred, and this is a good sign for the future. Events over the weekend show that problem firms can now be resolved without government playing a financial role even under extreme circumstances.
  3. Extraordinary uncertainty persists both with respect to the Lehman and Merrill transactions, and the market consequences. And the broader financial situation is likely to remain stressed for weeks to come. Other major financial firms are at risk of failing. It may prove necessary for government to play a more direct role in resolving weak financial firms to preserve normal market operations and the strength of the economy, but only in the most dire circumstances.
  4. The consequences of the Lehman and Merrill events for the overall economy will depend on whether credit remains available to good borrowers for homes, business investment, consumer purchases, etc. Financial markets, the Treasury, the Federal Reserve, and other regulatory agencies have a big task ahead maintaining fairly normal market operations.
  5. The Federal Reserve announced it is willing to accept stock as collateral for cash advances to help maintain orderly financial markets. This shows the Fed’s awareness of how badly stressed the financial system is at this time.

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