December 29, 2008
The Spirit of Bailouts Past
Tyler Cohen makes a good case that the 1998 "Bailout" of Long-Term Capital was both a bad precedent and sowed seeds of moral hazard in the very companies we had to bail out a decade later.
At the time, it may have seemed that regulators did the right thing. The bailout did not require upfront money from the government, and the world avoided an even bigger financial crisis. Today, however, that ad hoc intervention by the government no longer looks so wise. With the Long-Term Capital bailout as a precedent, creditors came to believe that their loans to unsound financial institutions would be made good by the Fed — as long as the collapse of those institutions would threaten the global credit system. Bolstered by this sense of security, bad loans mushroomed.
I don't know that I am completely convinced, but it is a solid case and a solid cause for concern. If that blossomed into this, than shall this become -- ooh, I don't like to think of it!
Hat-tip: Professor Mankiw, who is gaining converts to his bleedin' Pigou Club all the time...