When you ask whether Lehman Brothers should have been allowed to fail, you ask the wrong question. The real question is why Tim Geithner, New York Federal Reserve chief and the presumptive Treasury Secretary, saved Bear Stearns from the same treatment.

From the collapse of New Century Financial last year, Mr Geithner and Ben Bernanke, Federal Reserve Chairman, were in denial. They ignored the investor flight from the unregulated, over the counter paper the wizards of Wall Street and the City of London concocted. First with sub-prime and then ever higher grades of paper based on mortgages, car loans, buyout paper and everything else, investors fled to the safety of Treasury bonds, leaving short-term dollar rates at or near zero today.

Even when several Bear Stearns hedge funds began to totter from the same liquidity issues that were affecting mortgage-backed securities globally, the team of Geithner and Bernanke, marionettes guided by Hank Paulson, Treasury Secretary and former Goldman Sachs chief executive, did nothing.

When Bear Stearns finally began to experience funding problems, the regulators were still largely in denial - at least at the most senior levels. I can testify that regulators in the field have seen the macro meltdown of property and other sectors coming for years. But this was all still a surprise to patronage appointees such as Geithner and Bernanke.

When it was clear that Bear Stearns had to fail, I and other writers were horrified by what we saw as a rape by Bear's clearing bank, JPMorganChase, of the poor Bear shareholders, but now we see that $10 per share was quite a gift. Not only did Geithner, Bernanke, Paulson grant a subsidy to Bear's common shareholders and the complete salvation of the firm's bondholders and counterparties, including JPM and GS. But they did so by having the Fed eat $30billion in toxic waste now held in the vehicle called Maiden Lane.

But this bailout is even more costly than the loss to the taxpayer the rancid assets inside Maiden Lane suggest. By bailing out Bear, the Fed and Treasury gave the rest of Wall Street the impression that they were to be saved; that Helicopter Ben Bernanke would cause money to rain down and save the Street from its collective, global stupidity. Thus when Lehman Brothers was “allowed” to fail, the markets were surprised.

As industry veteran and investment manager Eric Hovde told me: “You could not prevent Lehman from going bankrupt unless the US Government was prepared to absorb a couple of hundred billion in losses. Lehman was a toxic waste dump. The bondholders are going to receive something like 10cents on the dollar. When people like [former chief executive] Dick Fuld say it was short-sellers, he is wrong. Short-sellers had nothing to do with it. The fact is that every buyer went in, looked at the books and records, and if it had been the case that the firm was just suffering from a depressed stock price, they would have scooped it up in a heartbeat. Nobody bought it because it was a toxic waste dump.”

There are a growing number of Americans who think that the bailout of Bear and AIG were horrible errors and that these two names should be in bankruptcy with Lehman Brothers. The same thinking is evident in opposition to a bailout for GM, Ford and Chrysler.

Keep in mind that the mounting funding requirements for the trillions of dollars in credit default contracts such as those at AIG are part of the reason for the squeeze on dollar funding globally. Put AIG into bankruptcy, along with JPM, GS and the rest of the credit default dealer community, and this idiotic pretence ends and we begin the process of rebuilding the global financial system.

— Chris Whalen is the co-founder of Institutional Risk Analytics, a Wall Street consultancy

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive