Why we shouldn't bail AIG/Goldman

Harvard’s Lucian Bebchuk writes in today’s WSJ why AIG can fail:

• Insurance policy holders are protected by their insurance subs (though ironically I recall AIG advertisements from just a couple of years ago selling insurance based on the supposed strength of the overall company).
• Losses to derivative counterparties would be “best addressed by the U.S. government (or foreign governments in the case of their banks) infusing capital directly -- in return for shares -- into the banks that need it.” (Could it be that this whole thing is about avoiding a direct payment to Goldman Sachs?).  
• Depositors in financial institutions, including money market funds, are now protected, as they were not when Lehman failed.

Bebchuk explains why we can let AIG fail. This is why we should:

• We cannot continue to both encourage risk-taking and to bail out failed bets. Moral hazard is not just a theoretical concern here. I wonder how Lehman and AIG would have been managed in the months preceding September 15, 2008 if Bear Stearns had not been bailed. Let's not compound that horrendous mistake.
• Bailing out AIG would contribute to a building assumption, which may become official if we get a “systemic risk regulator,” that a huge swath of our investment industry is backed by the government. If you like Fannie and Freddie you’ll love this.
• Our market-based economy demands accepting the market’s judgment on which firms should fail.
• We cannot tolerate additional US government control of financial institutions. Even if Treasury’s investment would be nominally debt, surely it would have actual or implied powers comparable to equity. AIG – and all the firms that would have to be bailed after AIG – would effectively become government institutions.

We should not accept these very serious consequences policy implications based on the ad hoc judgment of any Treasury Secretary, least of all this one.

Update:  The original version of this post erroneously stated that Geithner worked for Goldman.  Sorry, but it is an understandable mistake.

Comments

[Chris]

When did Geithner work at Goldman? I don't believe he ever did - nonsense conspiracy theories discredit your otherwise sound reasoning.