Sep 16, 2008 @ 11:57 am
NEW YORK - It's hard to talk about good news when a major investment bank files for bankruptcy and financial markets reel. This feels like the worst of times.
But the U.S. government had to broadcast to the world that the buck stops here, and that's why its decision not to bailout Lehman Brothers is so important to the long-term health of the financial system.
If market players think taxpayers always will foot the bill for their reckless behavior, then the current crisis will linger on and plenty more will come in the years ahead.
We'll hear many times in the coming days that the government drew a line in the sand with its decision not to save Lehman over the weekend. Before Sunday night, there was some belief that ailing financial firms would get a federal rescue; after that, it was clear no one should rely on a helping hand from the U.S. government.
Finally, we have a case of actions speaking louder than words. For months, we've heard officials like Treasury Secretary Henry Paulson say risk-takers wouldn't be rescued, but it was hard to really believe that.
Flying in the face of such assertions, the Treasury Department and the Federal Reserve took steps this year that were touted as ways to restore stability to the strained financial system and get credit flowing more freely.
Most notably, back in March, the Treasury stepped in as investment bank Bear Stearns nearly collapsed, and facilitated a takeover by JPMorgan Chase & Co. with the backing of a $29 billion federal loan. That month, the Fed also implemented the biggest expansion in its emergency loan program since the Great Depression, by allowing investment banks to borrow.
By July, struggling mortgage giants Fannie Mae and Freddie Mac also were given access to the Fed's lending program. But that wasn't enough--two months later, the government had to bailout both companies, pledging to provide up to $200 billion in capital to them if needed.
The government was criticized for such unprecedented actions because they fostered what is known as "moral hazard"--meaning that parties believe they were insulated from risk because someone would bail them out.
Former Fed Chairman Alan Greenspan warned that the Fed's actions could be viewed "as a wondrous new font of seemingly costless federal funding - a magical piggy bank," making such comments in a new epilogue to the paperback edition of his memoir, "The Age of Turbulence: Adventures in a New World."
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