Nobel Prize in Economics thanks to Lehman Brothers

It is curious that one of the largest financial bankruptcies in the history of the United States of America gave the Nobel Prize in Economics to the then president of the Federal Reserve, Ben Bernanke.

it has been many years since then. Bernanke has not been given the award in 2022 for his management of the financial crisis caused by Lehman. But yes for the work they have done over the last four decades on the role that bank bailouts play in financial crises.

It has been a work carried out by Bernanke with two economics professors: Douglas Diamond and Philip Dybvig. The work investigated banking regulation and the use of public funds to sustain or rescue financial entities in times of economic uncertainty, as well as to prevent even deeper crises.

Specifically, the prize stated that it was being awarded for showing how governments can use deposits and act as a lender of last resort to head off bank problems, given that rumors of bank problems stimulate withdrawals that heighten the danger for those same banks.

These withdrawals of funds also cause bear trading or stock sales and even short sales, when the bank’s situation is more delicate.

The Swedish academy believes that his work helped central banks and regulators respond to recession and uncertainty during the Covid-19 pandemic, establishing the maxim that avoiding bank collapses is vital.

And that Bernanke decided that it was best not to prevent the collapse of Lehman because legally it could not be rescued. Now, the work of American economists marks a change in that strategy.

It also has implications in the current crisis of strong inflation and aggressive interest rate hikes around the world. In theory, economists demonstrate with their work that bank runs or bank panics in which bank customers withdraw their money for fear of a collapse and cause the bank to be decapitalized and defaults are accentuated, are a decisive factor in the depth and duration of depressions.

And that risks can be reduced by using delegated supervision in which banks are intermediaries between savers and borrowers. Such tools could help minimize the severity of the current economic situation.

Before the fall of the banks did not matter

In a certain way, the previous orthodoxy assumed that the financial sector had a very limited role in economic peaks and crises (crashes) because it was limited to converting users’ savings into investments.

However, economists have emphasized in their work that borrowing money in the short term to make long-term investments (leverage, along with the transformation of maturities) made banks susceptible to these bank runs.

In fact, they were a very important factor in the Great Crash of 1930.

Ben Bernanke, Fed chairman from 2006 to 2014, was slow to respond to the financial crisis that erupted in 2008 and 2009, destroying some $1.4 trillion in the United States alone.

The Federal Reserve thought that the big local banks were sensible enough to avoid the crisis. But it was not like that. Since then, the solution has been to require banks to have more liquidity and higher levels of capital, as well as to limit their leverage. And despite this, those levels of capital and liquidity may not be enough to face a crisis, experts say.

Hence the award for the work of these three renowned economists. The Nobel normally rewards research that has been successful and applied with good judgment and results. But this has not been the case.

A lesson not quite learned by banks

Not if we understand that the world is once again facing a delicate situation and that there is not much hope that the financial sector will be a source of strength and not contagion.

Thus, the 2022 Nobel Prize in Economics may be a warning that what was done wrong then may still be being done wrong now and that, therefore, we might not have learned anything from the serious crisis of 2009 that started with the fall in Lehman Brothers misfortune.

At the moment, the current crisis seems to favor trading in the shares of some specific banks, but, despite the rate hike, not the entire sector. Something must still be there that does not encourage bullish trading in financial stocks. Perhaps, deep down, we agree with the economists and accept that the global financial sector has not yet applied the lessons of the 2009 crisis.

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Nobel Prize in Economics thanks to Lehman Brothers