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On March 13, 1964, at 3:15 am, Kitty Genovese, a 29-year-old bar manager, was stabbed to death in front of her Kew Gardens building in Queens, New York. A newspaper article printed two weeks later suggested that her neighbors had heard her cries for help and yet remained unresponsive. In the case of Miss Genovese, rumors of her neighbors' unwillingness to come to her aid proved to be inaccurate. However, it is a more recent event in March of 2008 which is a better example of the "bystander effect", or the social psychological phenomenon of "diffusion of responsibility" - the Bear Stearns collapse.

In August of 1998, as a result of heavily leveraged trades in the currency markets, Long Term Capital Management was on the brink of collapse. The usual suspects on Wall Street banded together to discuss the systemic risk of allowing a large hedge fund to implode. All agreed that some sort of bailout or rescue package should be cobbled together despite the strenuous objection of Jimmy Cayne, chairman of Bear Stearns, who believed that LTCM should be allowed to fail and let the markets absorb the shock.

Fast forward to March of 2008. The shoe is on the other foot, Bear Stearns is on the ropes and the firm's share price is falling fast. Here is where "diffusion of responsibility" comes in. "Diffusion of Responsibility" is a social phenomenon which tends to occur in groups of people above a certain critical size when responsibility is not explicitly assigned. Diffusion of Responsibility can manifest itself in a group of peers who, through action or inaction, allow events to occur which they would never allow if alone ("bystander effect") or, in hierarchical structures, where underlings claim they were following orders and supervisors were just issuing directives and not acting per se (think Sgt. Schultz from "Hogan's Heroes").

Bear Stearns, after railing against a bailout for LTCM in 1998, desperately needs a bailout to keep itself independent. But the bankers have a long memory, and psychologically, their inactivity results in a bystander effect - "We can't do nothing for you, man, good luck!". This is a firm that is a counterparty to trillions of dollars in derivative instruments, but irrationally, the Street feels that Bear Stearns should get whatever they deserve. Everyone is watching the stock chart and munching popcorn like they were watching "Nightmare on Elm Street" until, finally, the Fed steps in and declares that JPMorgan (JPM) will absorb Bear Stearns at 2 dollars per share in order to protect "systemic risk" from occuring. As an afterthought, the share price is bumped up another six dollars but the damage is already done. The message to Wall Street is clear - You are all on your own and when you can go on no longer, the Fed will reanimate your corpse to do the bidding of your trading partners.

This message was driven home by the "conservatorship" of the GSEs, where many commentators have compared the organizations to "the Living Dead".

Michael Lewis wrote a terrific article entitled "Joyous Loathing at Lehman Brother's Collapse" where he states that an unintended result of the bailout boom has been Wall Street's diffusion of responsibility now that the United States government has devoted itself to playing helicopter mother to all of its problem children.

Deals like the TPG infusion into Washington Mutual (WM) seem insane in this climate. Why would any firm give a capital infusion into a financial institution if there was a slight chance that the government could shove its way to the front of the line and dilute the equity or debt to the point of oblivion?

But Michael Lewis pointed out a deeper underlying psychological rationale to Lehman Brothers' (LEH)misery - that a company which had been opaque and shrouded in secrecy is now loudly flailing about, airing all of its dirty laundry to the world in an effort to keep itself from being killed and reanimated. This is tabloid fascination. This is the sordid life of the Royals. This is driving slowly past an accident and rubbernecking. This is not going to have a happy ending.

Disclosure: No positions

Source: Lehman: Victim of F&F Bailouts Plus the Bystander Effect