Saturday, December 27, 2008
Tyler Cowen discusses the fateful mistake by Alan Greenspan of bailing out the creditors of Long Term Capital Management (the fund managed by neoclassical financial academics testing their mathematical theories in practice, a test which failed spectularly) that I have discussed before. Although this wasn't the only bailout before this crisis, it was arguably the biggest and most spectacular one, and therefore it was the bailout that created most moral hazard, and so was a minor contributing cause of the current crisis. We are now experiencing the long run during which Keynes claimed we would all be dead. As Cowen points out, while failure of LTCM may have led to deleveraging then, it would have been far better to do so then with much smaller imbalances.