Credit crisis: Lessons from Lehman's collapse

Economic Times

BEIJING: The US government's decision to take its hands off the country's fourth largest debt ridden bank Lehman Brothers and let it fall has sent a stark message to other financial institutions.

"Lehman's collapse was earth-shaking news for the world financial market. It blew away the myth that as long as they (the financial institutions) become large and reach far they can beg for government help when in emergency," said Jia Guowen, a financial analyst on a national TV programme.

Lehman ate up too much bad debt and unfortunately became the only victim in this crisis so far, but it also taught others a lesson, Jia said.

In their relentless quest for expansion, the banks must make sure they ward off possible risks involved in the business instead of plunging into distress and waiting to be bailed out by the government.

Some analysts compared the financial crunch to a relay game in which everyone passed the risks to the next - from lending banks to investment banks to evaluation institutes to insurance companies.

When numerous houseowners failed to pay back their debts, the relay game came to a stop - the banks have to digest the depreciated real estates and the insurers also pay the toll, analysts said.


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In an effort to stabilize the credit market and prevent further economic downturn, the Bush administration has planned to buy $700 billion of bad debt and encourage financial institutions to restore normal lending.

The sweeping cleanup plan will be the US government's largest financial bailout since the Great Depression of the 1930s.

"This is a big package, because it is a big programme," President George W. Bush said Saturday at a White House news conference.

"I will tell our citizens and continue to remind them that the risk of doing nothing far outweighs the risk of the package."

Treasury Secretary Henry Paulson said the plan would address the root problems of the financial crisis gripping the country - bad debt on financial institutions' balance sheet.

"As illiquid (which is not readily converted into cash) mortgage assets block the system, the clogging of our financial markets has the potential to have significant effects on our financial system and our economy," Paulson said last week.

Critics say the US government has been inconsistent in its reactions to market events.