Slate’s Unpersuasive Case for Further Massive Government Sponsored Moral Hazards
[H]ere’s the richest irony: Bankruptcy means that Lehman is going to get bought anyway. In the last 15 years or so, bankruptcy has become a familiar, almost cozy neighbor: Airlines, for example, seem to go in and out of bankruptcy all the time. But those are Chapter 11 bankruptcies, which allow businesses to stay alive as going concerns. Investment banks like Lehman are generally supposed to file under Chapter 7, which involves appointing a trustee who will essentially liquidate the firm’s assets. As we are writing this, Reuters is reporting that Lehman will use Chapter 11there are loopholes for thatbut it remains likely that Lehman will be liquidated.
So think about this: By declining to offer the kind of guarantees that would have made Lehman an acceptable risk for the likes of Barclays or Bank of America, the U.S. government has forced Lehman into bankruptcyunder which its assets will get bought for pennies on the dollar. It’s hard to see how that is a better outcome than having Lehman bought for some low, $2-a-share price, as Bear initially was.
I am not persuaded.
As I recall the feds bailed out BS not because of some we-must-maximize-share-prices-for-failed-investment-houses norm but because BS was so integrated into financial markets that the ripple effect would be catestrophic. To be sure, the Big Money folks think that the same is true of Lehman Brothers as well. We’ll see, I suppose. On the other hand, a sale in bankruptcy and a sale backed by the feds is NOT the same thing. For one thing, the equity holders get wiped out in bankruptcy, which is as it should be given their status as the residual holders of risk. Second, bankruptcy sales will dismember the firm and sell off the assets bit by bit. The fact that Lehman Brothers couldn’t find a buyer without a federal guarantee of its assets means that the portfolio of assets that it held wasn’t worth buying. Why keep them together then? Finally, if Lehman had sold at $2 a share that would have been $2 per share of capital in the hands of Lehman Brother’s stock holders that wouldn’t have been invested elsewhere. If the only way of getting that $2 a share into the hands of Lehman stockholders is with a big government carrot, then the market is telling us something about the allocative efficiency of putting the capital in the hands of those stock holders. Better to put it elsewhere.