Lehman's collapse put strain on the system. A system under strain is more vulnerable to new stresses, not least is the subsequent lack of trust between financial institutions, which in this case saw inter-bank lending rates shoot up. Within weeks of Lehman's collapse, both AIG and Washington Mutual also failed
AIG and WaMu were both on the verge of bankruptcy independent of Lehman. I don't think there is any causal relation between Lehman's collapse and theirs.
Inter-bank lending rates did go up. This is precisely the kind of price signal that markets generate and which in turn modify the behaviour of their participants. Higher rates cause banks to reduce lending to each other, which in turn reduces the kind of inter-dependencies that worry you.
What more proof do you need? Is your argument really "we didn't suffer complete financial meltdown so there was no effect"?
Any kind of proof would be nice. We have none - only hysterical pronouncements by power-hungry politicians and whining of their banker cronies. I didn't claim Lehman's collapse had no effect - allowing more banks to fail would certainly have had some effect, but we have no good reason to suggest it would have let to the kind of melt-down that governments used to justify immensely costly (in the short term) and distortive (in the long term) rescues.
Governments are bureaucratic and act slowly. They wouldn't be capable of reacting fast enough to stop serious social unrest if a major retail bank failed.
Yet you trust them to know when and how to rescue banks? You trust them with hundreds of billions of dollars?
In the slightly longer term, some losses by individuals wouldn't be catastrophic to society or the economy, but would help sensitise people to look into the credit quality of the institutions in which they invest their money. Nothing would work to make bankers cautious and responsible more than market discipline.
Firstly, bailing out each individual saver in a retail bank is likely to be considerably more expensive than a bank bailout.
I understand your point. You are assuming that a bank failure in the presence of credible deposit insurance would still lead to a run.
A run, however, is not an unmitigated disaster. If people know that their checking account is safe, the need to withdraw will be greatly mitigated. In the past we had lines in the streets, but not riots or breakdown of society.
If the experience of a bank in which you trusted your money failing is a bad one, that will cause people going forward to give some attention to which banks (or which types of accounts) they trust. Nothing will cause bankers to behave prudently more than knowing that the alternative is to lose business.
From a libertarian principled perspective, I expect several consequences to withdrawal of government intervention in retail banking:
1. Banks will both become, and advertise the way they are safe. Large equity (i.e. shareholder capital) component in the balance sheet will help, as will rating reports and cross-guarantees from other financial institutions.
2. Banks will start offering 100% reserve deposits. Whether the underlying money is gold or fiat, there is no reason why a bank shouldn't be able to offer a perfectly safe account (albeit not an interest-paying one). Most people would split their financial assets amongst several banks, and keep some of those assets in such perfectly safe deposits. For a reason I still don't fully understand, there is no current mechanism for a commercial bank to segregate cash holdings from the assets of the bank itself. Banks can do that for securities (such as government bonds) but not for cash.
Free men are not equal and equal men are not free.
Government is not the solution. Government is the problem.