Monday Sep 15, 2008

Avoiding "Moral" Hazard

In a credit crisis, the "lender of last" will weigh options, now having to balance the desire to provide liquidity versus its desire to ensure market dynamics ("Credit Crisis Strains Government's Options," WSJ, Sept. 12, 2008):

Officials are also acutely aware of the problem of "moral hazard." Bailing out too many firms, the reasoning goes, would encourage more risk taking in the future. That makes officials reluctant to be seen as rescuing another institution. The Fed made a $29 billion loan to help J.P. Morgan take over Bear Stearns. It's not clear that it would be willing to do that for another firm.

Treasury Secretary Henry Paulson has said that institutions must be allowed to fail and that markets can't expect the government to lend money or support every time there's a crisis. "For market discipline to constrain risk effectively, financial institutions must be allowed to fail," Mr. Paulson said in a speech in July.


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