When a Fund Bet on a Bailout

It's always interesting how our priors affect our reaction to new information. Leonard sees this story and concludes that we can't rely on markets for risk management and self-correction. It doesn't occur to him at all (or at least he makes no mention) that the government created a huge moral hazard by facilitating the Bear bailout a few months earlier.

Arnold,
"Too regulated to fail." That's a keeper.
Best,
David

One of the things I find so funny is all the people complaining that risk was mispriced for years. But, with all the bailouts (see AIG), was the true risk badly mispriced? Looking out over the entirety of what has happened, the entities that mispriced risk the most were government institutions.

"That investment was nothing other than a bet that Lehman would be considered "too big to fail."

We had, and still have, a financial system in which such bets make sense. I see that as a problem. The financial reforms on the table do not address that problem. If anything, they exacerbate it. They promise, in effect, to make firms "too regulated to fail." Ultimately, that is an inherently self-denying promise."

What I've been trying to argue is that this was our system prior to Lehman. In other words, almost all of the bets were against Lehman being allowed to fail. People were not prepared for anything else. To verify this, all that you need to do is read the accounts of actual investors from the week of Lehman. Investors were scrambling into cash. I'm sorry, but that is a disaster in today's interconnected financial market, because a lot of people in that scramble will go bust.Too many.

We need to change the system. But it's going to take time. In my mind, this necessitates having a long term strategy that allows for slow but steady progress. Of course, I'll accept big changes if they're to my liking.