Monday, September 29, 2008

Where to draw the line?

When is a company too big to fail?

That's one of the critical questions in the current credit mess. The Wall Street Journal explains how the decision to let Lehman Brothers fail turned out to be disastrously wrong.

It was wrong because it turns out that no one knows which investors have exposure to which financial instruments. Including the investors themselves. It's something like a financial butterfly effect: a subprime loan defaulting in Cleveland can cause a storm in Hong Kong.

That appears to be the logic behind the Treasury plan's focus on the underlying assets. If the bond secured by that subprime loan doesn't default -- or if the default is absorbed by the taxpayers -- then the damage to holders of related securities can be contained. We hope. Since no one knows how the various assets are connected, no one knows who the ultimate winners and losers will be.

(Wall Street Journal links; subscription required.)

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