Tuesday 18 March 2008

The Fed and Bear Stearns (updated x2)

Megan McArdle comments on the JP Morgan buy out of Bear Stearns.
Yes, this is creating moral hazard that we'll have to deal with, probably unpleasantly, down the road. But whatever the moral hazard, it is hard to see how it could be worse than the full-blown financial crisis the Fed is trying to avert.
Trying to avert, just how far will the Fed go the avert such an event. The further it does the bigger the moral hazard problems. The more the Fed tries to help Bear Stearns the more it signals that risk taking behaviour is ok with it and thus the more risk will be taken. If firms think they have some of their downside risk being covered by the Feb, you will get riskier behaviour.

Update: Over at the The visible hand in economics they are not so worried by moral hazard, see Moral hazard in the Bear market. But see Matt Nolan's view in the comments.

Update 2: The Economist takes the view that
... the moral hazard police are almost certainly overstating their case. It's very difficult to call the Bear buyout a bailout, given the paltry sum for which it the firm was sold, and no one has been hurt as bad by the collapse as Bear employees and shareholders (often the same people). The lesson here is not that excessive risk taking will be rewarded by a nice government safety net. Moreover, JP Morgan could, potentially, be the big winner from this deal. If anything, the weekend purchase is a message that firms who avoid overexposure to dangerous risk may be given the opportunity to cherry pick assets from their more foolhardy competitors, with Fed assistance.

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