The only thing anyone knows for certain is that today will be tumultuous for financial markets, after a historic Sunday that has remade Wall Street. With Lehman Brothers probably on the road to liquidation, and Merrill Lynch to be acquired by Bank of America, we are getting a Category 5 test of our financial levees.
In the event of a Lehman bankruptcy, we will also get a test of whether a major broker-dealer can fail without triggering a systemic crisis. As of last evening, the Federal Reserve and Treasury had refused to offer the same taxpayer guarantees to Lehman paper that it had for Bear Stearns last March. That was enough to cause Barclays and other potential Lehman acquirers to walk away.
The result will be a very rough Monday, but the government had to draw a line somewhere or it would have become the financier of first resort for every company hoping to buy a troubled firm. Especially with the Fed discount window now wide open to many more financial institutions, and to many kinds of collateral, Treasury Secretary Hank Paulson's refusal to blink won't get any second guessing from us. If Lehman is able to liquidate without a panic, and especially if its derivative contracts can be safely undone, the benefits would include the reassertion of "moral hazard" on Wall Street. The Merrill acquisition before it faces a Lehman-like run should also reduce the risk of contagion.
In the days ahead, Treasury will have to take more aggressive steps to protect the banking system -- including, perhaps, another Resolution Trust Corp. that can acquire real-estate and mortgage assets when there are no other buyers, provide some floor under prices, and liquidate or sell them in more orderly fashion. Whatever happens today, we'd rather not repeat the exercise.
Click here for the WSJ online version of this editorial.
SPA-2008
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