Tuesday, September 9, 2008

Moral Hazard

Rescue Risks Setting Stage For New Woes


By MARK GONGLOFF, Wall Street Journal


The government's rescue of Fannie Mae and Freddie Mac may have averted a financial meltdown, but it could create other unintended problems.


In the short term, auto makers and other troubled industries might use the move to argue that they, too, deserve a taxpayer lifeline. Some foreign governments will use Uncle Sam's generous backstop as justification for market controls that may not be quite so constructive. And the move might further fan the election-year populism that already has free-market advocates gnashing their teeth.


The potential longer-term consequences may be more troubling. For one thing, unlike equity holders, debt holders in financial companies once again have been protected, as they were with Bear Stearns and others. That may lead these lenders to examine those companies less carefully, putting more burden on regulators to sniff out problems, warns Gerard Caprio, economics professor at Williams College and a former World Bank official.


What's more, lawmakers and regulators will eventually have to figure out how to shrink Fannie and Freddie, redistribute their portfolios and refine oversight of the U.S. mortgage business. Missteps could create loopholes that savvy investors can exploit, warns Anil Kashyap, a business professor at the University of Chicago and student of past financial crises.


In such regulatory soups new opportunities and risks are born. The Resolution Trust Corporation that ended the savings-and-loan crisis in the late 1980s led to a booming mortgage-securitization market that dumped buckets of cash on Wall Street. It also planted the seeds of the mess the government this weekend stepped in to solve.

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