Posted by: Tobias | November 13, 2008

More Moral Hazard after Lehman

This response to those who think letting Lehman default was a good idea because it would reduce moral hazard seems blindingly obvious once you’ve read it:

A lack of a Lehman bailout only reduces moral hazard if investors think it is a preview of future actions. But the failure to bail out Lehman has been blamed throughout the world press and by world leaders (see, e.g., Lagarde in France) as the cause of the world-wide credit crisis. The cost of the Lehman failure made clear to world leaders the cost of allowing a major broker-dealer bank to go under. Because it is widely considered a mistake (whether or not it actually was one), the Lehman non-bailout makes a bailout for the next major financial institution more likely. Hence, moral hazard was increased, not decreased by the decision not to bailout Lehman.

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