Some thoughts on Risk-Sharing

For a while I've been watching the Treasury's bailout efforts, and wondering if perhaps the Feds should only be investing in banks for which there were private investors were also willing to step up to the plate and match the investment. Sure, this will close down some institutions that are too far gone, but so long as the FDIC can swoop in and move those assets off to surviving financial institutions, and the co-investment program can make sure that there are surviving financial institutions, I think that it all works - that is to say, we end up with a smaller number of more healthy institutions, no taxpayers discover that their net-worth has suddenly gone up in smoke, the federal gov't does not end up holding the bag, and managers who backed throwing risk-management controls to the wind get removed from positions of financial authority over large sums of other people's money¹.

But I haven't thought it through, enough, and I wasn't entirely sure that it didn't have huge, sweeping downsides that I didn't immediately see.

Now, it seems that the Treasury may have come to the same conclusion. Interesting.

Note 1: My real concern with Moral Hazard, as it's termed, is that public policy should not make the best way, or the most obvious way, to make lots of money be to defraud the public. I'm okay with someone getting paid large sums of money if they make other people even larger sums of money. I'm not okay with someone making large sums of money when they're losing even larger sums of other people's money, unless the situation is that someone is successfully managing to lose only large sums of other people's money, while everyone else is losing very large sums of other people's money. Basically, I'm much more worried about perverse incentives than I am moral hazard.