First it was Bear Stearns. Then the government bailed out Fannie Mae and Freddie Mac. Before the ink was dry on that deal, Uncle Sam loaned $85 billion to insurance giant AIG in exchange for an 80% stake in the company. Along the way, the Fed has been throwing money every which way, depending on the day.
But wait: there’s more. In the last 24 hours, a new round of government bailout efforts are underway. Yesterday, Congressional, Federal Reserve and Treasury officials were talking of launching a massive government fund to buy up the toxic securities from investment banks and other institutions. Meanwhile, the SEC announced a ban on short selling on nearly 800 financial stocks. And the Treasury is now insuring money market funds to shore up sentiment in the wake of news that the Reserve Fund—a money market portfolio—broke the buck this week, i.e., its net asset value fell below $1. The drop stoked fears that even cash equivalents might not be safe.
The government, in other words, is throwing everything but the kitchen sink at the bear market. There’s some logic to this, of course. Preventing bank runs and the like is just common sense. But how much is too much? Or too little? Alas, intervention is an art, not a science. Financial turmoil of the degree we’ve seen this week is rare, and so there’s not a lot of precedent. The early 1930s are an obvious era for study, but the relevance is limited, since two or three things have changed the days of FDR and “brother can you spare a dime.”
Meanwhile, asset prices want to fall, and interest rates want to rise (i.e., those rates that involve private parties that can’t print their own money). But the government is doing everything in its power to keep Mr. Market from having his way. This is reasonable, up to a point, although it’s a safe bet that it’ll take time before we know where reason ended and moral hazard began.