Both the past and future of our financial system remain as poisonous a topic as they were five years ago, when Lehman Brothers failed. That is a lesson to draw from the forced withdrawal of Lawrence Summers, former US Treasury secretary, from the list of candidates for chair of the US Federal Reserve. For many Democrats, Mr Summers is responsible for the financial liberalisation that led, in their view, to the crisis of 2007-09. Indeed, the debate about the origins and aftermath of the crisis is not over. How can it be when the exceptional policies it caused are still with us?
The fifth anniversary of Lehman’s failure is an opportunity to assess where we have come from and where we are going. How important, for example, was Lehman’s failure? It was less significant than many believe, for two reasons. The less important one is that a financial crisis was on its way, anyway. The more important one is that the financial crisis was a manifestation of overstretched balance sheets. These impaired balance sheets are, in turn, the reason a strong recovery has been so long in coming.
This is not to argue that the decision to let Lehman fail in September 2008 was unimportant. The shock began a devastating run on markets. An indicator of these stresses is the spread between three-month Libor (the rate at which banks could supposedly borrow from one another without offering any security) and the overnight indexed swap rate (the implied central bank rate over the same period). This spread, already elevated, started to widen on the day of Lehman’s failure. It kept on widening as the financial dominoes kept on falling in the US and Europe. The stresses revealed in this measure of the perceived solvency of banks peaked on October 10. (See chart.)