Andrew Clare
Professor of Asset Management at Cass Business School

If the cost to the wider economy is far higher than the cost of bailing out a company, then you bail out. And it has to be the taxpayer who foots the bill, doesn’t it? Who else is there left?

Clearly, the regulators took the view that Lehman should be allowed to fail and, as we’ve seen over the past couple of days, people have been buying parts of what’s left. And let’s face it, the world didn’t exactly end when Lehman went down.

Basically, AIG was embedded far more deeply into the financial system and, therefore, a failure of AIG could have been potentially catastrophic for everyone, so the authorities took the view that the systemic risk involved in AIG was far higher than the cost of the bailout.

But you don’t bail out for the sake of it. Taxpayers shouldn’t pick these bills up just because the banks are going bust. There needs to be careful weighing up of the likely consequences of the bust relative to the cost of the bailout. The regulators made a legitimate choice not to bail out Lehman and decided that its failure would not bring down the global financial system.

In terms of moral hazard – the idea of setting an example to others in the industry – letting a bank go to the wall is a good thing. Bankers see that there are consequences for their behaviour. But, sadly, it is not all about multimillionaire traders losing their jobs – a lot of people at Lehman are doing ordinary jobs like IT, administration, middle and back-office roles.

Unfortunately, they’ve had to pay the direct price of the reckless behaviour of some of the bankers – the overlending that has been going on – and I think that is sad. But it is not a deterrent to others if you bail out banks and let the bankers keep their bonuses. I certainly don’t think it can hurt to let some of these banks go to the wall. The problem is that in the current environment it creates more uncertainty, and the greater the uncertainty the more likely it is there will be another run on another institution.

All industries have failures. We don’t all rush to bail out shoe manufacturers, but we do know there are consequences for bailing out some financial institutions, and the regulators have to work out which ones they can allow to fail and which ones they will have to prop up. They took the view that AIG was too big to fail.

But it needs to be made absolutely clear who has access to the lender of last resort and who does not. Clearly, the authorities have widened that access dramatically, in the past six months or so, to an insurer, which has been unheard of previously. And if firms don’t have access to the lender of last resort, then their debt and equities will need to be priced accordingly.

Richard Portes
Professor of Economics at London Business School

If there are losses to be covered and it is a matter of saving the financial system from collapse, then taxpayers do have to pay and always have done. If you want the financial system to collapse, you don’t bail out anybody, the system collapses and you have a serious depression.

My view is if the system is assured that you will deal effectively with financially distressed firms, then there will be fewer financially distressed firms and you won’t have to bail out everybody. I think Lehman should have been helped, precisely because of where we are now.

The authorities did not backstop the financial stability of Lehman Brothers, the financial system is down and we are feeling the consequences. You may say they are responsible for their own problems – that the Bear Stearns and Lehman Brothers executives, and so on, these masters of the universe, were deeply flawed – but that does not mean we should let the firms go down.

Regulation exists partly because we know at the end of the day that if a firm gets into distress we may have to bail it out. That is why you have regulation to stop them getting into those circumstances, because the assurances may encourage irresponsible behaviour. But the answer to that is good regulation, much better than we have seen. The authorities must say: “We are not going to let any big firms fail, we will let the equity be wiped out, we will see the back of the management if firms are driven to that point, but we are not going to permit these liquidity crises.”

The idea that if you bail out firms now the industry will do the same things next time round is not supported by history. Fewer than 20 years after the S&L crisis we have the sub-prime crisis. Many firms were allowed to fail in the 1980s, many managements thrown out, shareholders left with nothing. But who made the deals of the past few years? Who constructed the highly complex securities? They weren’t around during the Long Term Capital Management crisis in the 1990s. They had no experience of loss and did not perceive the risk.

Certainly, we will see more regulation and a lot will be bad, but if one consequence of this is that the regulators pay more attention to what is going on in leading firms, then that will be positive. I would bail out as many important firms as need it – and I would make it clear in advance – and I would have more regulation, in the sense of putting more effort and resources into following the balance sheets and liquidity positions of systemically important firms. What I think may be a mistake is to say: “We have to regulate the hedge funds, we have to regulate the credit rating agencies, tell them what they can and can’t do.” I don’t think that will be effective.

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