[flourpower]

We shouldn't practice financial regulation like it's holistic medicine. Metaphors about cleaning the pipes and taking the pain should be weighed against the evidence we have about what happens when you let banks fail, and that didn't go very well when we did it with Lehman Brothers.

[TomOfTTB]

The failure of Lehman Bros. did not directly cause the financial collapse.

The financial collapse was caused when other banks realized how bad Lehman's balance sheet was. Because their own balance sheets were also bad and they deduced all the other banks out there are probably in just as much trouble.

So banks stopped lending to each other and that's what caused the collapse.

But those circumstances wouldn't have changed if we bailed out Lehman. Because the realization would still have been the same.

[MaysonL]

So far this year, 73 US banks have failed, with resolution handled by the FDIC. Bank failures don't have to be horrific. We would arguably be better off as a country if rather than bailing out the big banks they had been taken over, recapitalized, and reprivatized.

[intended]

They aren't hardly at the scale of Lehman/BoA though - its hard to imagine a failure of one of those banks being handled by the FDIC with anything approaching grace or control.

While the greater point may be true, it does have the benefit of hindsight to a certain degree.

At the same time - after seeing the effects of Lehman's collapse, the regulators really didn't have any other choice than saving those banks. The option of not acting really wasn't there.

[MaysonL]

True, obviously action was necessary, but it didn't have to be no-strings bailouts. At the very least, the bankers who ran their banks into [probable] insolvency should have been removed from control, and their shares and options rendered worthless.

[rwmj]

Out of interest, what bad stuff happened when Lehman Brothers collapsed?

Beyond a few thousand job losses (likely temporary, and about 0.01% of the US economy).

[Estragon]

  - Credit markets seized up because no one could tell who 
    was insolvent.

  - Massive outflow of foreign capital from the US as  
    investors realized what a mess the US financial system
    must be in.
    

I'm in favor of letting a bank like Lehman Bros collapse despite that. The most important thing for day-to-day economic health is to make sure no one loses retail deposits, and Lehman Bros wasn't even in that business. But what should have followed is much more intrusive regulation and oversight of the financial industry to determine exactly who is insolvent and arrange an orderly writedown of people's bad financial positions. Unfortunately, the disproportionate political power of the financial industry made such a policy impossible to implement. (See the recent book Confidence Men.)

[bd_at_rivenhill]

The most important thing for day-to-day economic health is to make sure no one loses retail deposits

You're ignoring the money market here. I just looked up some numbers, and Forrester research peged the amount of deposits at FDIC insured banks at $6.9 trillion at the end of 2007 (http://www.forrester.com/rb/Research/industry_essential_us_r..., although the number of insured dollars is probably a fair bit lower than that due to limits on the size of insurable deposits), while the Institutional Money Market Funds Association gives $3.6 trillion in money market funds. Money market funds are marketed as being equivalent to bank deposits (down to the ability to write checks against them) and many retail investors don't understand that they aren't insured.

[iqster]

Good response.

I recall reading (think this was in Too Big To Fail) that the deciding powers were afraid that if there was another Lehman, cash would stop coming out of the ATM machines. This is what prompted AIG and a few of the other shotgun marriages.