The Fairness of Financial Rescue

Financial bailouts are understandably controversial, because they reward those who bet on risky assets. But a policy that leaves owners of risky financial assets impoverished is a policy that shuts down dynamism in the real economy.

BERKELEY – Perhaps the best way to view a financial crisis is to look at it as a collapse in the risk tolerance of investors in private financial markets. Maybe the collapse stems from lousy internal controls in financial firms that, swaddled by implicit government guarantees, lavish their employees with enormous rewards for risky behavior. Or perhaps a long run of good fortune has left the financial market dominated by cockeyed optimists, who have finally figured that out. Or perhaps it stems simply from unreasoning panic.

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