This evening, the Federal Reserve agreed to take an 80% stake in AIG, the world's largest insurer. Between Fannie Mae, Freddie Mac, and now AIG, the portfolio of shaky assets owned by US taxpayers is becoming quite impressive.
More important, I think we can say that the notion that financial markets can be trusted to regulate themselves has now been well and truly kicked in the head.
I don't pretend to understand credit default swaps -- apparently the people investing in them didn't either -- but I can accept the argument that the Fed had to act because the consequences of AIG's collapse would be catastrophic. The corollary, though, is that market discipline can only be trusted if one is willing to accept the occasional catastrophic collapse. Which, clearly, we are not.
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