Lorenzo Bini Smaghi, a member of the Executive Board of the European Central Bank, gave a thought-provoking speech in Milan last week. In particular, he focused on the role of democratic politics in responding to the financial crisis and, more broadly, in how governments manage their economies. Smaghi begins with the premise that it was a mistake to let Lehman fail in mid-September (not everyone agrees with this, but many people do), thereby triggering the acute phase of the credit crisis. He then asks why this happened.
As subsequent events have shown, in particular when the first rescue package was rejected by the US Congress, opposition to providing the financial sector with public funds came not only from within the government, but also from parliament. The Members of the US Congress, many of whom face voters at the beginning of November, feared that such a decision would compromise their re-election. There was opposition to rescuing Lehman Brothers, therefore, not only from within the Administration, but also from Congress and, more broadly, from public opinion. In other words, the decision was largely the result of a democratic process.
The Baseline Scenario 