trade-offs
In a column in the New York Times, the financial writer Roger Lowenstein commented on the long-term effects of the Fed’s decision to help bail out the hedge fund LongTerm Capital Management (LTCM): The concept of too-big-to-fail, exceptional in 1998, is now a staple in the regulators’ playbook. Bear Stearns and, by implication, other troubled investment banks have been taken under Washington’s protective skirts; Fannie Mae and Freddie Mac, too. . . . If individual responsibility is to be fully excised from American capitalism, the free-market enthusiasts who founded Long-Term Capital deserve no little credit.
a. Why did the Fed participate in the bailout of LTCM?
b. What does Lowenstein mean by “individual responsibility”? Connect the idea of individual responsibility to the concept of moral hazard.
c. What trade-offs do policymakers face in confronting the problems of moral hazard and systemic risk?
d. What did policymakers feel could happen if LTCM were allowed to fail?
e. The excerpt above mentions that the LTCM founders were “free market enthusiasts.” Is there a contradiction between free market principles and the too-big-to-fail policy?