Short-run pain, long-run gain from Lehman stance

By Glenn Somerville - Analysis

WASHINGTON (Reuters) - As messy as financial market conditions are right now, the weekend decision by U.S. government officials to let Wall Street firms stand or fall on their own should strengthen them in the long run.

Some analysts think more bailouts are possible and virtually everyone expects further failures like the collapse of 158-year-old Lehman Brothers LEH.N, but the government took a solid step toward limiting a perception that it will backstop every faltering firm.

"The government's action drew a line in the sand in a troubling situation where no choice (to use taxpayer money) was the best choice," said Allen Sinai, chief global economist for Decision Economics in Boston. "That's the single bright light in what remains a very dark situation for the U.S. and global economic situation."

As financial institutions crumble under the weight of a housing crisis that shows scant sign of easing, the U.S. Treasury and the Federal Reserve are aiming to recalibrate their earlier willingness to offer loan guarantees, as they did with Bear Stearns in March, or take over companies, as was done with Fannie Mae and Freddie Mac earlier this month.

"Throwing these problems back in the hands of the private sector -- telling them we'll help broker solutions but don't count on us to be the solution -- is the right solution," Sinai said. "The body politic has had enough of bailouts."

Treasury Secretary Henry Paulson, at the White House on Monday, sought to underline his determination that business must set its own course in troubled waters by saying he "never once" considered using taxpayer money to help Lehman.

"I think it's important that regulators remain very vigilant but I do not take lightly putting the taxpayer on the line for an institution," Paulson said. "It's important for us to maintain the stability and orderliness of our financial system; moral hazard is something I don't take lightly."

Moral hazard is the concept that investors may take greater risks on the belief that the government will protect them from suffering losses.

"BEGINNING OF THE END"

Certainly the bankruptcy of Lehman Brothers Holdings Inc sent shockwaves through markets on Monday. The Dow Jones industrial average plummeted more than 500 points and the dollar dropped in value, while bond prices shot up as investors ran for safety.

"The next six to 12 months will be extraordinarily difficult for markets and the global economy, but what this past week's events signal is less likely the unraveling of the financial system than the beginning of the end of this unprecedented crisis," said economist Mark Zandi of Economy.com in West Chester, Pennsylvania.

There was widespread feeling that Paulson was trying to revive the idea that businesses need to come up with their own solutions. The Lehman stand could be seen as an example that America will be better off taking its financial pain upfront rather than putting off solutions as happened in Japan during the 1990s when it became mired in a decade-long malaise.

"He's saying the market is efficient and the market is going to judge you by your own decisions," said Edward Craig, managing director and head of U.S. cash equities trading at Jefferies & Co in New York.

The Federal Reserve "made a very powerful statement in letting Lehman go into bankruptcy, because that suggests they want to reduce moral hazard," said William Sullivan, chief economist at JVB Financial Group in Boca Raton, Florida. "That was the correct decision in my opinion."

(Additional reporting by Ellis Mnyandu and John Parry in New York; Editing by Leslie Adler)