Lehman and the Crisis

John Cochrane and Luigi Zingales opine.

Update: Phill Swagel, who was Assistant Secretary of the Treasury for Economic Policy at the time of the Lehman collapse, emails me the following commentary:

While I have a great deal of respect for John and Luigi, their oped in today's WSJ is misleading in important aspects. One example is this passage:

"It did not help that the TARP was such a transparently bad idea. The Fed and Treasury soon figured that out, settling on equity "injections" and a bank-debt guarantee instead. Floating a bad idea does not instill confidence."

The problem here is that it would have been impossible to start with capital injections -- a proposal for the government to buy 20 percent of the banking system would not have passed the House of Representatives. This was a hard constraint. John and Luigi might think that the initial TARP proposal was a bad idea -- that's a discussion I'd be glad to have -- but it is misleading to make this argument in comparison to an infeasible alternative. They should consider instead the choice between the TARP as originally envisioned to buy illiquid MBS and the (feasible) alternative of not having any TARP and thus not having the ability to switch to capital injections as financial market conditions deteriorated in the ensuing weeks.

This is all discussed on page 38 and following in the paper I wrote for Brookings in April. To find the discussion of this point in my paper, search for the phrase "politically oblivious."

Thanks, Phill.