AIG, moral hazard, and “depression economics.”
I don’t have much to say about the initial financial crisis, other than lots of bankers made lots of bad decisions. And through experience I have found that virtually nobody finds that bland explanation satisfactory. At the same time I have always had a nagging feeling that moral hazard played a bigger role in the financial crisis than was apparent at first glance. A very interesting recent post by James Hamilton shows how moral hazard contributed to the crisis. He described the insurance giant AIG as a sort of hedge fund, which made an enormous bet insuring mortgage-backed bonds, even though:
AIG lacked the financial resources to make good on those contracts in the event that the housing downturn became as severe as it has now proved to be.