Comment on Wyplosz's column

Posted by on 25 February 2009

With the benefit of hindsight, it is easy to criticize the decision to let Lehman Brothers go down. The decision triggered a costly near-meltdown of the global financial system, which in turn caused, or contributed to, an extremely sharp global economic downturn. Even if one accepts the internal logic of that decision, it would still have been better and cheaper to have nationalized Lehman, and then gradually unwound the bank. Many observers, including myself, saw it differently at the time. But very few observers still think that allowing Lehman to go down was a good idea. I am very surprised to hear that Charles Wyplosz is among them. A decision to allow a euro area member state to declare default would risk an even greater catastrophe. Within seconds of such a decision, the financial markets will have launched a full-blown speculative attack on the bond markets of every southern European country plus Ireland, either directly or via credit default swaps, the perfect speculative instrument for such occasions. Within hours, Italy would have warned that it will not be able to roll over its debts. Moody’s and S&P would have downgraded all southern European bonds to junk-grade level, and may downgrade Germany by a notch or two, on the grounds that bailing out a insolvent banking sector plus five or six European governments simultaneously might be touch ambitious. Who would want to take such a risk at a time like this? Wolfgang Munchau Financial Times