The economic reasoning behind bailout or no bailout.

As 2008 continued, though, economists started to wonder if the exception was becoming the rule. When the Treasury took over Freddie Mac and Fannie Mae, it was an acknowledgement of an implicit expectation on the part of investors, who had been generous historically to the mortgage giants because of their government affiliations. As with Bear, a substantial amount of Freddie’s and Fannie’s debt was held by foreign parties. Had the Treasury not stepped up, it’s likely that financial institutions around the world would have stopped lending to them entirely, which would have more or less shut down America’s mortgage business. In the case of AIG, the government was worried that huge payouts on credit default swaps (essentially, insurance on sketchy real-estate debt) would leave the company bankrupt and its customers uninsured, at least for a time.

Was it the right thing to do? One of the problems with the phrase “moral hazard” is that it invokes a concept of morality over a decision about which there is little morality easily discerned. Based on stock market performance in recent days, it’s hard to see the bailing out of AIG as being any more moral than not bailing out Lehman, no matter what reasoning lay behind the decisions. Yet as easy as it is to armchair-quarterback the Treasury’s decisions, the fact remains that we’re in uncharted territory. No economist today has ever worked through a panic or a depression, and the ubiquity of technology and the global reach of modern financial institutions make the 19^th- and 20^th-century models pretty much obsolete anyway. We are still learning what constitutes moral hazard, and what its contemporary effects are.

Explainer thanks Tom Baker of the University of Pennsylvania Law School, Alex J. Pollock of the American Enterprise Institute and Lawrence White of the New York University Stern School of Business.