Dean,

You nailed it.

Taking it a step further, FDIC insurance is the ultimate moral hazard situation.

Robert and Dean,

You are wrong. FDIC insurance only covers up to $100K per account (at least that's the stated principle). If large depositors are dumb enough to deposit $1 million at a bank, they are taking a risk. Of course, you will say what aobut Bank of New England or the too-big-to-fail theory. That's true but it's not automatic or guarantee that you will get your entire $1 million back. Moreover, it will take a long long time to recover that amount from the FDIC.

A large gty as the Bear's one, it often comes with some kind of cease and desist order. I don't know for sure if there's one. So do you know if there's one?

James wrote, FDIC insurance only covers up to $100K per account (at least that's the stated principle). If large depositors are dumb enough to deposit $1 million at a bank, they are taking a risk.

What if they split it into 10 accounts?

James,

So you don't think a few banks out there might be a bit concerned if FDIC insurance was pulled?

On a related note, have you seen a good explanation or evidence that the bankruptcy of Bear would have brought down the world economy? They make some hand wavy statements about how Bear was involved through networks or swaps in staggering amounts of derivatives and debt, but really, how does this mean Bear dies, world collapses?

Certainly the employees and officers of Bear were not bailed out.

But as you note the purchasers of the mortgage derivatives are now insured by the U.S. gov. That appears to me to be a guarantee and a reward.

How do these risktaking consumers differ from the risktaking homeowner currently facing the loss of their home? Their wealth?

The discouraging thing is how this happens over and over (e.g. S&L's, Continental Illinois, LCTM etc.) and the media, pundits and even many economists don't learn.

The idea that the demise of Bear Stearns would mean the collapse of the world economy is obviously in the interests of Wall Street, but it is also something that tends to bulk up the reputation and importance of the Fed and monetary policy in general. If we don't have another Great Depression, this will be another instance of the "Maestro", now Bernanke, saving the world.

Ummmm, the way I understand it this deal isn't limited to FDIC amounts. Bernanke has basically guaranteed _all_ Bear Stearn's assets. Period.

Erik L wrote, but really, how does this mean Bear dies, world collapses?

Not sure I think it's true, but the rationale is that Bear dies, can't honor its contracts. So the counterparties on various contracts---particularly derivatives---get stiffed. This causes some of them (particularly those that are leveraged) to have problems, creating a cascade.

Hi,

The comments are quite interesting. The moral hazard question is compelling. If we are to have a robust financial market that is "self-regulating" as many claim the market be, then the investment banks must have the freedom to fail as well as the freedom to succeed. I don't know whether anyone involved can reliably estimate the consequences of a Bear-Steans failure. It seems that everyone can recognize that financial transaction that created the Bear-Stearns crisis have either been unregulated or under regulated.

The key areas that regulation should address are:

1. leverage; and

2. financial accounting reporting.

We traditionally have regulated bank leverage through capitalization and reserve reqirements. My understanding is that the Federal Reserve, the Comptroller of the Currency and the Federal Deposit Insurance Corporation all play arcane roles in the process of defining and regulating bank leverage.

The financial accounting and reporting regulation is, to my understanding, much less well regulated. The same institutions, the Securities Exchance Commission and the Financial Accounting Standards Board all play some role.

Does anyone believe that the business practices employed by investment banks could would fly under the public's radar screen if the regulators actually required the investment banks to disclose their capital, their leverage and their potential liabilities arising from the "derivatives", "swaps" and other financial instruments the investment banks so glibly trade?

Let's hope we can find a few grownups willing to run for office impose sensible regulation on the investment banking industry. If we don't we shall be bankrupted by Wall Street bailouts.

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The diagnosis is not at issue: moral hazard risks abound.

The cure, then, will maximize the likelihood that gratuitous moral hazard is too impolitic.

Historically, a job largely for the fourth estate (e.g., Jacob Riis, H.L. Mencken).

How, then, to make it maximally profitable for the fourth estate of today to muckrake?

Imho, the key insights:

1) The introduction of particular online markets, starting with a new kind of market for the ad spaces on blogs, will provide people with new and improved ways to develop, showcase and profit from expertise.

2) Owning popular markets of the aforesaid kinds is an ideal way to increase profits for an American media conglomerate that owns a broadcast TV network.

3) The less benefit individual speculators can derive from moral hazard, the more they will utilize said markets.

Details are online at http://www.loveatmadisonandwall.com.

Given the above, the sooner media conglomerates start introducing/popularizing the aforesaid markets, the sooner a lot of top-quality entertainment programming will, in part:

1) increase awareness of (proposed) public policies that (would) put taxpayers on the receiving end of gratuitous moral hazard (e.g., increase awareness via a next-gen Jed Bartlet channeling Jon Stewart and Vietnam-era Walter Cronkite)
2) showcase elected representatives who protect taxpayers from gratuitous moral hazard

Thoughts?

Best,

public policies that (would) put taxpayers on the receiving end of gratuitous moral hazard.

this is very good