Credit Swaps May Further Imperil Markets

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ROBERT SIEGEL, host:

From NPR News, this is All Things Considered. I'm Robert Siegel

MICHELE NORRIS, host:

And I'm Michele Norris. Now, we get to see what happens when the government does not step in. Bankers spent the weekend asking the Fed and the Treasury Department to help bail out Lehman Brothers. This time, they said no and let the nearly 160-year-old bank go bankrupt. Why didn't the government step in like it did for Fannie Mae and Freddie Mac last week or for Bear Stearns in March?

NPR's Adam Davidson has been following this story, and he has some answers. Adam, when the government stepped in before, they said it was to avoid a systemic failure of the global financial system. Were they not worried about the same thing this time? Why is Lehman different?

ADAM DAVIDSON: You know, they were worried about a systemic failure of the global financial system, which is exactly as awful as that sounds, but they were also worried about a systemic crisis caused by the government bailing out bank after bank after bank. And they decided to take the risk this time.

They decided - from what all the reports have it, Henry Paulson simply sat there all weekend and said no. They sat around at the table, and the bankers from Lehman Brothers and other banks kept asking please, please, please. There's a crisis. Please help us bail out Lehman Brothers. And Paulson just said no, no, no, even though he knew there were serious risks here.

NORRIS: Now, when you talk about the risks, you talk about bank after bank after bank failing in this sort of domino effect. Walk us through what could have happened.

DAVIDSON: Well, the fear this weekend was that - it's not the direct effect that Lehman would collapse, and the people who own Lehman stock would lose all their money. The fear was that Lehman is very big in something called the credit-default swap market. It's basically a form of insurance, so banks and hedge funds and pension funds all over the world pay Lehman money to have an insurance policy against their losses.

So if Lehman disappears one day, all of those insurance policies disappear. Suddenly, banks all over the world have much less protection. Just like if your homeowner insurance suddenly disappeared, you might feel anxious about that. And those banks might freeze up. They might stop lending money because they were afraid of the losses that they can have without insurance.

Then, those banks would freeze up, and then their client banks would freeze up and on and on and on. You have a ceasing of the system. That didn't happen, but it seemed to be a reasonable fear.

NORRIS: OK, so it didn't happen, at least not yet. Where are we now in the crisis? Are we starting to see the effects of this overseas, for instance?

DAVIDSON: We're definitely seeing this overseas. This whole crisis began last August 2007, so over a year ago. We've been hearing again and again, OK, we're near the end. OK, this is the worst thing yet, and now, it's over. This is the worst thing yet, and now, it's over. I am not hearing that very much now. I am hearing from people on Wall Street, from economists and analysts, let's just wait and see. I'm not hearing those rosy pictures anymore.

I'm hearing fear and pessimism. I have to say for the short, I don't know, another six months another year, this is not the end of capitalism. This is not the end of progress. This is a lousy year to 18 months. It's a restructuring of the American banking system. That's what we're talking about.

NORRIS: Fear and pessimism, that does not give comfort to many of our listeners, who perhaps are wondering how this might affect the average person. One last question, Adam, for the person who doesn't work in the investments sphere or in Lehman Brothers or in Merrill Lynch, what does this mean for them?

DAVIDSON: Short term, it means your 401 K or your investments are worth less, and you have to sit that out. That's part of investing. Long term, you've got to hope that the system doesn't seize up like I described, and there's not much the average person can do about it, just wait.

NORRIS: Thank you, Adam.

DAVIDSON: Thank you.

DAVIDSON: That was NPR's Adam Davidson, and you can find more explanations of what happened today and over the weekend. You'll find that at npr.org/money.

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