Oh, You Have GOT To Be Kidding…

The Fed is going to bail out AIG.

Scratch pretty much everything I’ve written—apparently the price of failure is now a nice government bailout. This is a phenomenally bad precedent, even if it saves the markets some short-term pain.

UPDATE: Jim Cramer was pushing for an AIG bailout tonight. If AIG had gone down, would the financial markets have gone down with it? Would the Dow have dropped another 1,000 points? Perhaps.

The problem is that by buying AIG, the damage is still going to be done, it’s just the taxpayers and AIG shareholders who end up holding the bag. Perhaps that’s the best that can happen here, but that doesn’t mean that anyone should like it. The U.S. government should not be in the business of bailing out insolvent corporations. That creates a major problem with moral hazard that can’t be ignored.

What we’ll get out of this (regardless of who wins in November) is more regulation—and not necessarily better regulations. We’re still capitalizing profits and socializing risks, and that’s exactly what got us into this mess.

Saving AIG might have saved the Dow from crashing below 10,000—or it might have set the stage for more problems in the future. Sometimes avoiding short-term pain produces long-term sickness.