The financial meltdown's unhappy anniversary
The crisis that began with the Bear Stearns debacle is about to enter year three. Yecch!
NEW YORK (Fortune) -- We're about to mark the second anniversary of the financial meltdown. But don't expect to see any clinking of champagne glasses, because except for a handful of prescient (or lucky) speculators, it's been a ghastly two years. The nightmare started June 12, 2007, when news broke that two Bear Stearns hedge funds speculating in mortgage-backed securities were melting down. That was the precursor to the panics and collapses that have led to a worldwide recession and the fall of mighty institutions like Bear, AIG (AIG, Fortune 500), Lehman Brothers, and Royal Bank of Scotland (RBS).
But even a clinkless anniversary has its uses -- it's an occasion to reflect on the past and contemplate the future. So let's look at what the meltdown is really about, the unappreciated impact of Lehman's collapse, and where we go from here.
Yes, the meltdown started with subprime mortgages - "subprime" is a Wall Street euphemism for "junk" - but it has spread far beyond that. Problem areas now include credit cards, construction loans, office buildings, shopping centers, leveraged buyouts, nonjunk mortgages, and the various and sundry securities based on all that stuff. So even if the U.S. housing market were miraculously restored to health tomorrow - not likely - we'd still have major grief.
What almost everyone (including me) missed two years ago is that the world's financial system was a disaster-in-waiting. It was clear that housing prices, leveraged buyouts, and such were being driven by vast amounts of money looking for something to buy, no matter how idiotic. What wasn't clear is the way the markets were interlinked and internationalized. Thus, piggish behavior in the U.S. - financial swine flu, as it were - sped around the world even faster than regular swine flu has.
Enter, or rather exit, Lehman, which failed in September 2008. Financial markets freaked, for reasons we'll get to. The markets' problems dragged down the economy, creating a slowdown that's been putting a second hurt on the markets. It's the first time we've seen this pattern since the Great Depression. Creepy stuff.
Letting Lehman croak seemed rational, after the uproar six months earlier when taxpayers bailed out Bear Stearns's creditors and allowed Bear shareholders to get $10 a share for stock that was essentially worthless. But unexpected consequences of Lehman's failure scared the pants off the world's financial-crisis managers. First, because of a little-noted 2005 change in U.S. bankruptcy laws, Lehman's counterparties - the institutions on the other side of huge bets that Lehman made - were able to seize and sell the collateral that Lehman had posted. Those sales drove down asset prices, inflicting huge losses on other institutions and fomenting fear as institutions grew ever more wary of dealing with one another. Second, Lehman's collapse led to Reserve Fund's becoming the first sizable money market fund to "break the buck" and inflict capital losses on investors. That scared millions of people.
Finally, some hedge funds that had Lehman as their prime broker - the institution that holds their securities and cash and does their transactions - couldn't get access to their assets after the bankruptcy. Other funds began moving their prime brokerage accounts out of Goldman Sachs and Morgan Stanley, which as investment banks couldn't use all the Federal Reserve's emergency-borrowing programs. That put the two in a bind and forced them to become bank companies.
These unexpected consequences of Lehman's collapse help explain why U.S. regulators have been so solicitous of the 19 big "stress test" institutions. Who wants to close, say, Citi (C, Fortune 500), and be responsible for a Lehman II?
Despite the huge stock market run-up the past three months, things are still far from good. The government's rescue strategy seems to be the traditional "play and pray" of past crises. You play for time, pray that all the money being thrown at the markets and the economy will turn things around, and hope banks make enough profit to heal themselves.
Will it work? Or will we turn into another Japan, where banks and the economy were stagnant for a decade? Ask me in a year. Meanwhile, an unhappy anniversary to all of us. 
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