Dollars and Jens
Monday, March 17, 2008
Fed officials don't dispute that their decision carries "moral hazard" — the risk that any sort of bailout encourages more of the same risky behavior later. But they believe that compared with the alternative scenario, that cost is small. The funding is structured so that the greater benefit is to those who lent money to Bear Stearns in the "repo" market for secured, overnight loans, not to Bear Stearns itself. Moreover, they note it's unlikely any firm will consider the loss Bear Stearns's shareholders are likely to sustain as an acceptable price for taking the same risks in hopes of a bailout.I think that's a fair assessment.
The equity holders sure weren't bailed out, but the counterparties and bondholders kind of arguably were (though, as I mentioned earlier, the reaction of JPM's stock price today suggests that Bear Sterns without liquidity issues is worth well over zero). This kind of bailout might make senior lenders less scrupulous in their vetting. But I think that's a much smaller consideration.
Megan McArdle makes the same point.
UPDATE: Drexel economist Joseph Mason thinks I shouldn't be so dismissive of moral hazard in counter-party risk. He's probably right. Though in this particular case, it was more of a liquidity thing than a long-run risk thing; if the federal reserve can reliably tell the difference (a big if, I grant), I have no objection to their routinely bailing out liquidity situations and letting fundamentally bad companies die.