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September 14, 2009

Out of the Crisis, Now What?

Andrew Ang
Professor, Finance and Economics
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A year ago this morning, we woke up to the news that Lehman Brothers had collapsed. The overnight demise of the investment bank is an important milestone, but it is only one failure in a series of calamitous events in the last year that shook the financial world and changed it forever.

Entire markets essential for world commerce effectively shut down and some markets continue to remain moribund today. Last year at this time, the whole banking system was on the verge of collapse and the world economy was tanking. Now that the economy is stabilizing — even perhaps tentatively recovering — and the financial sector is healthier, it is easy to forget just how bad things were.

It is true that investors today are now more cautious and banking will (hopefully) become more boring. But the financial and economic landscape has been permanently altered. The single biggest change pre- and post- Lehman Brothers’ failure is the role and the actions of the government and other financial authorities.

Before Lehman’s fall, the government played a relatively small direct role in financial markets. Now, the most important player, and still in some cases the only player, in financial markets is the government. The government essentially chose Lehman’s fate and allowed some of its peers to survive. Masses of money — tens of thousands of dollars per U.S. household — were injected by the United States Treasury to save the banking system from itself and bail out bankrupt industries. Unprecedented intervention by the Fed in markets, still continuing today, has slowly enticed investors back.

But now one year later, we can look back at how the government led us out, but the big question is: Where is it going to lead us next?

Photo credit: T. Shein

Comments

by ray horton | September 14, 2009 at 1:05 PM

It's nice to see that one of my colleagues doesn't lay all of the blame for the crisis on the government. As to where it will end up, my prediction is a bigger (and for Marxists, better) crisis next time around since Wall Street (my shorthand for the dominant players in financial markets) will beat back Obama's regulatory attempt more confident than ever that their risky business will continue to be backed up by taxpayers. Some institutions can have their cake and eat it too.

by John Hughes | September 21, 2009 at 10:54 AM

As an unabashed fan of Professor Ang let me respond by saying that government intervention can be a slippery slope. Government intervention in the finacial markets will lead to further imbalances in cost of capital and asset prices which will in turn lead to malinvestment and income disparity ( as it has in the last decade). "Prices send signals" said the Austrian economist von Mises. The price discovery process in financial markets is critical to an efficient allocation of capital and failure is a critical component of capitalism. The cost of intervention can be insideous and cumulative. And it is hubris to believe that the Fed is omnipotent. A deficit spending government may control the amount of liquidity in a system but it will be the lenders to that government that ultimately determine the price.

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