Hank Paulson and Ben Bernanke proved that they were not anarchists, willing to risk the financial system burning itself into a pile of ashes. Zeus-like, the Fed will bail out AIG (AIG) at the same time it failed the shareholders, employees, and some customers at Lehman Brothers (LEH).

The conventional reaction to the news was that the federal government has adopted two sets of rules. The Fed will loan AIG $85 billion for two years and take a 79.9% share in the insurance company for good measure.

The Fed articulated its reasons, but did not clear up how they would be applied in future decisions:

"The Board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth, and materially weaker economic performance."

The government has undermined the free market system. It based the decisions to help Fannie Mae (FNM) and AIG on arbitrary swings in human judgment which ultimately are not grounded in one set of principles.

Free markets are never "free". They assume a certain amount of regulation so that some of the players will not act irresponsibly.

In AIG’s case, government officials and bankers may have hijacked the system by lobbying to keep jobs intact and prevent more abominable losses which might well have pulled under several more banks and brokerage firms.

At this point, the financial system may have to tolerate a level of regulatory uncertainty to go with the economic uncertainty which already roils the markets. In some cases the government is willing to own US financial firms. In other cases, it is willing to throw them to the wolves.

Risk is either akin to financial markets or it is not. Making a decision about how much risk is too much risk ex post facto only tells firms that they can dive off a cliff and still be saved. Moral relativism has marched into the system and any sense that actions have consequences has been muddled.

Douglas A. McIntyre

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