The Moral Hazard of Moral Hazard

First there was "too big to fail." This created a moral hazard which encouraged risky plays like PIMCO's forays into Lehman bonds. "Uh, oh. We have too many bailouts. If we don't let someone fail, we'll have to bail out everyone." So, they let Lehman Bros. go bankrupt. And, they tried to create a firewall by bailing out the next target: Merrill Lynch. Brilliant move. Except for one thing: Paulson and Bernanke forgot that there was someone right behind Merrill. AIG stepped right into place, probably in deeper financial straits because of the Lehman bankruptcy.

So, we have these moral hazards, and counter moral hazards that border on the metaphysical. If there's a bailout, then risky behavior is encouraged. However, most of the risky behavior as been committed long ago. Joe six-pack's pension fund is getting whallopped now. This makes bailouts more palatable for everyone.

Now that there is no such thing as "too big to fail," we have another problem. The government is on its own. Why should there be another Bank of America/Merrill Lynch bailout when you can wait for your mark to go bankrupt and pick over the bones. Just see Barclays getting the piece of Lehman that they wanted for a song.

Boy am I glad I got out of most of my shorts this week! Whew!