An interesting piece in the Times of London has a few nuggets on banking of note, but overall indicates a vast indulgence in 20/20 hindsight. They’re ignoring the fact that housing prices really did experience a bubble that had to pop eventually. Lehman was the match, but the bubble was the gasoline.

In early September of 2008, as the tectonic plates were sliding into place for a major event, Hank Paulson had just finished de facto nationalizing Fannie Mae and Freddie Mac. This was done surgically and quietly. It didn’t kick up a fuss in the press because, even though these two entities were as large by assets as all of Wall Street combined, most people have no clue who they really are and what they do.

But if Paulson had proposed to do with the entire US banking system what Britain did with Northern Rock, he would have been laughed out of office. He chose to handle Lehman as he did because he wanted to avoid what did happen with Bear Stearns six months earlier: the assisted suicide of Bear created a firestorm of controversy about moral hazard, a word no one even mentions any more.

As I recall, a great many conservatives at that time said “LET BEAR STEARNS FAIL, THE BASTARDS, AND GET A TASTE OF THEIR OWN MEDICINE!” It was pretty lonely being where I was, objecting to my conservative friends, and warning about the hell that would break loose. It did break loose in September.

This whole situation is a lot like preemptive war. George Bush will go down in history as the man who ruined war for everyone by moving on Iraq. And what if he hadn’t? He just might have gone down as the man who allowed a whole string of 9/11-style disasters to hit the US, including nuclear attacks. We’ll never know.

Again, though, I have to stress that the bubble was the real problem. It would have found another way to pop even if we had managed to keep the banking system from blowing up.

I think what the Times is saying is that the world would have been a better place if we had guaranteed the banks (and the shadow banks, and the CP market, and the securitizations, and interbank lending, etc etc) three days before Lehman went down rather than three days later.

If we had done that, we’d still be arguing about why Morgan Stanley (who refused to forbear on the margin call that was Lehman’s last straw) got $5 bn from the taxpayers. It’s amazing how the amount of political acrimony in the system remains the same, regardless of the size of the problem. And that’s the real reason why policymakers don’t pop bubbles preemptively.

Moral of the story: it’s never a good idea to save the lives of a lot of people, because they’ll return the favor by coming after you with pikes and pitchforks. If they’re all dead, they can’t do that.