Ever since the Federal Reserve arranged for the acquisition of Bear Stearns and opened the discount window to investment banks, the phrase moral hazard has been on everyone's lips. The idea is that by relieving Bear Stearns investors and creditors of the full cost of Bear's failure, the Fed encouraged more risky behavior.
Today Michael Lewis proposes a new kind of moral hazard created by this series of moves by the Fed and the Treasury. He says that the bailouts have led market participants to believe that they don't need to worry about the collapse of another investment bank because the government will step in. Where once Wall Street would have scrambled to prop up Lehman, as it did Long Term Capital Management, now it feels secure enough to watch Lehman go down.
People are enjoying its failure. The pleasure and interest the markets now take in seeing it fail now exceeds their pleasure and interest in seeing it survive.
This is one of the many unintended little side effects of the government bailout of Bear Stearns Cos.: to greatly reduce the interest of the people who do business with Lehman Brothers in the survival of Lehman Brothers.
All those people whose affairs are intertwined with Lehman might have pressured them to handle their problems more briskly and intelligently -- and might also be trying to keep it afloat. The U.S. government has made it possible for them to instead stand back and watch with some detachment and even pleasure as Lehman collapses.
After all, the Federal Reserve will give them their money back, re-insure their credit defaults, take another pile of these distressed assets out of the market. And when the dust settles they can go in and poach Lehman's business and its smarter employees.
Lehman's stock is down another 40% this morning.
Joyous Loathing at Lehman Brothers' Collapse: Michael Lewis [Bloomberg]