Lehman's Legacy: Three Years Later, the Financial System Remains a Powderkeg

Lehman Brothers turns 3 years old today. Not the investment bank. That's history, surviving only in the netherworld of bankruptcy protection. Three years after the Wall Street firm's collapse, however, Lehman carries on as a symbol and object lesson. Trouble is, of what?

The lessons are less evident, and more contradictory, than they seem. Many, including the court-appointed examiner who conducted the inquest into Lehman's demise, see the case as a textbook failure in financial regulation. Under this view, the SEC should've seen it coming, as the bank joined the speculative orgy that precipitated the housing bust.

Others think the failure was less a matter of lax government oversight than poor judgment. Former U.S. Treasury Secretary Henry Paulson and then New York Federal Reserve chief Tim Geithner didn't have to let Lehman fall on Sept. 15, 2008, the theory goes -- that was their call.

Some see Lehman's collapse as proof that huge financial institutions remain "too big to fail." After all, U.S. officials' decision not to back-stop the company's losses, as they had with other large financial institutions caught up in the mortgage mess, nearly brought down the global financial system. Total catastrophe was averted, but only just. Will the U.S. government similarly tempt fate the next time a crisis threatens big banks, which in the interim have grown even bigger, or will they rush to their rescue?

Yet government financial watchdogs insist that such risks are under control, pointing to their new "resolution authority" to close insolvent financial firms. Whether they will choose to exercise it is another story, since such decisions are inevitably mired in politics. And even if the federal will is strong, questions remain regarding just how you go about shuttering a financial institution with operations all over the world.

Lessons for Europe: Bank runs kill
For those watching the debt crisis infecting the eurozone, Lehman is a case study in what not to do. Geithner even felt compelled this week to say that there is "not a chance that there will be another Lehman." Phew, that's a relief! On the other hand, the Treasury chief recently said there was "no risk" that the U.S. would lose its AAA credit rating. Nostradamus he's not.

More important, the parallels between the bank run that caused Lehman to crash and the loss of confidence in major European banks exposed to Greek debt are unmistakable. Both Lehman and Greece were once considered too small, relative to the whole of Wall Street and the broader European economy, to start the dominoes toppling.

Now we know better. And as in the U.S. in 2008, the pathways of contagion in Europe today also run through large, interconnected banks (channels that snake back to the U.S. economy, of course). Wrote the FT's Gillian Tett recently in drawing comparisons between Lehman's meltdown and the ominous signs in Europe:

[N]obody can deny that there is a rising sense of déjà vu, to use a phrase from France, the core of the eurozone. The Gods of Finance might chuckle. Then weep.

The trick is in how you insulate the system from harm in the short-term and repair it in the long-term. On both counts, Lehman's final legacy won't be known for years.

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