Monday, September 15, 2008

Cooperation in the International Financial System

. Monday, September 15, 2008

As you may already know, Lehman Brothers, one of the largest investment banks in the world, filed for bankruptcy today after a very long weekend of negotiations that included the main power players of American (world) finance, could not save the investment bank from failing. The Federal Reserve Bank and the US Treasury drew the line this time around and firmly held that they would not provide tax payer money to rescue the investment bank or facilitate a takeover of the troubled firm by another institution (as they did in the Bear Stearns collapse in March) and that the market itself would have to find a solution to the problem or allow the bank to fail.

The New York Times had some interesting analysis on the around the clock negotiations that occurred over the weekend. They paralleled the weekend negotiations with a similar round of talks that occurred during a bank run in the early 20th century:

Over the weekend, the Federal Reserve Bank of New York called together the leaders of most major financial firms in an effort to get them to act collectively to stem any possible panic, but could not force a deal.

In a way, that was similar to what happened a little more than a century ago, when the financier J.P. Morgan called the heads of all the trust companies in New York to a meeting in his library, and demanded that they agree to put up money to stop the bank run at another trust company.

The bankers did not want to do so, in part because they would need that money if the panic spread. Morgan locked the door, and kept the presidents in the library until morning, when they finally gave in. No such coercion exists this year.

This very interesting narrative got me to thinking. How does cooperation come about in the international (or domestic) financial system? Does a coercive mechanism have to be in place to in a sense force the hands of other firms to produce the liquidity necessary to save another financial institution? Do these institutions have to be coerced by the government, a central bank or another mechanism to take over a failing entity? Is it in the best interest of competing financial firms to bail out a competitor in order to ensure confidence in the financial market? Does the government have any responsibility to bail out a failing firm? How do we deem when a firm is too big to fail? Who deems it to big to fail and who saves it from failing? Fascinating questions that would make for an interesting research program (ahh dissertation!)

What do you think? Discuss!


Cooperation in the International Financial System




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