I'm not sure that this is really new news. The Washington Post is using a somewhat exaggerated title here.
Personally, I recall, in early September (2008), thinking that it would be great if the Fed let a large financial operator fail. I am fairly stupid, and sometimes I think in terms of simple cause and effect, and this was a clear case of that - I was thinking it would send a clear message that financial firms needed to get their act together. Then Paulson and the Fed allowed Lehman to fail. My first thought was, "This is great, now the other firms will get the message." I was totally innocent about the extent of the leverage in the system and the degree of peril the other firms faced. As the disaster played out in late September, I realized how naive I'd been. I suppose most people, like me, learned only then how weak the system was. The Fed's unusual decisions were well known by the early of October (2008). If you read blogs like CalculatedRisk, one could follow the unorthodox extensions of the Feds programs. They were unusual, but I recall, there was the sense that orthodoxy had been discredited with the collapse of Lehman.
There was a good post on Calculated Risk at one point (early 2009, I think) about the benefits of paying out the full dollar on defaulted financial instruments, even to foreign firms - foreign banks had lent huge sums to finance mortgages in the US, if the foreign banks were to dump those loans, then the prices of US homes would have been driven down even lower and faster than what was already happening.
prices of US homes would have been driven down even lower and faster than what was already happening.
Then we would have affordable housing. Why is that a bad thing?
I think we exchanged the short term pain of some bankruptcies for the long term pain of years of deflation. Outstanding credit will continue contracting for many years, probably for more than a decade. This is deflationary.
Iceland let its banks go bankrupt and now it has a growing economy again.
Second of all, it is easy for a small country to bounce back by devaluing its currency, but it is harder for a big country to do that. To devalue is to gain via exports (or import substitution), but to grow Iceland by 1% requires less of the world than getting the USA to grow by 1%. This is a simple matter of ratios. The USA represents a greater total of the world economy than Iceland does, therefore its requires more of the world economy to get the USA to grow 1% via exports (or import substitution).
Thirdly, a lot of banks have been allowed to fail:
Fourthly, no doubt some of the bigger banks should also have been allowed to fail. Nationalization and rehabilitation would have been more fair to the public than simply bailing out the existing management.
Fifthly, please think about what you are writing: "the short term pain of some bankruptcies for the long term pain of years of deflation". There is no trade off there. Bankrupt banks lead to decline in the monetary base which will lead to deflation unless offset by some other factor, such as massive devaluation, as in the case of Iceland.
Personally, I recall, in early September (2008), thinking that it would be great if the Fed let a large financial operator fail. I am fairly stupid, and sometimes I think in terms of simple cause and effect, and this was a clear case of that - I was thinking it would send a clear message that financial firms needed to get their act together. Then Paulson and the Fed allowed Lehman to fail. My first thought was, "This is great, now the other firms will get the message." I was totally innocent about the extent of the leverage in the system and the degree of peril the other firms faced. As the disaster played out in late September, I realized how naive I'd been. I suppose most people, like me, learned only then how weak the system was. The Fed's unusual decisions were well known by the early of October (2008). If you read blogs like CalculatedRisk, one could follow the unorthodox extensions of the Feds programs. They were unusual, but I recall, there was the sense that orthodoxy had been discredited with the collapse of Lehman.
There was a good post on Calculated Risk at one point (early 2009, I think) about the benefits of paying out the full dollar on defaulted financial instruments, even to foreign firms - foreign banks had lent huge sums to finance mortgages in the US, if the foreign banks were to dump those loans, then the prices of US homes would have been driven down even lower and faster than what was already happening.