The Line in the Sand...

apparently just got wiped out by the tide.

Yesterday, Treasury Secretary Hank Paulson was gaining kudos for his refusal to bail out Lehman Brothers. He had drawn a "line in the sand" and we'd all be better off for Treasury's "tough love":

All summer, U.S. Treasury Secretary Henry Paulson and Fed Chair Ben Bernanke talked about "moral hazard." Firms need to be careful, they said, because the government is not going to come to the rescue of just anybody.

But then came Bear Stearns, and Fannie and Freddie:

But in March, the Federal Reserve swept in with a $30 billion credit line to help JP Morgan Chase scoop up Bear Stearns. And just a week ago, the Treasury announced it was spending billions to take over Fannie Mae and Freddie Mac.

Observers, such as Former Fed Chair Alan Greenspan, who cautioned that Washington was getting too close to viewing the Fed as "a magical piggy bank," wondered if Paulson and Bernanke had the stomach to let a big bank fail.

Seems they do.

As one EPSN football analyst likes to say: Not So Fast My Friend.

Today, we learn that the Fed has bailed out insurance titan AIG:

The U.S. government seized control of American International Group Inc. -- one of the world's biggest insurers -- in an $85 billion deal that signaled the intensity of its concerns about the danger a collapse could pose to the financial system.

The step marks a dramatic turnabout for the federal government, which had been strongly resisting overtures from AIG for an emergency loan or some intervention that would prevent the insurer from falling into bankruptcy. Just last weekend, the government essentially pulled the plug on Lehman Brothers Holdings Inc., allowing the big investment bank to go under instead of giving it financial support. This time, the government decided AIG truly was too big to fail.

Congratulations. As an American taxpayer, you now own an insurance firm.

Here's the Economist's take:

They may have had no choice. Markets did not completely fall apart after Lehman’s bankruptcy, as some had feared, but they were highly agitated...Officials worried that the collapse of AIG, with its $1 trillion balance sheet and operations in 130 countries, could send the financial system into a tailspin....The AIG bailout shows how hard it is for America’s financial authorities to steer a straight course through a crisis that is piling one systemic threat onto another.

Former Labor Secretary Robert Reich (Clinton) captures the political irony:

Ironically, a free-market-loving Republican administration is presiding over the most ambitious intrusion of government into the market in almost anyone's memory. But to what end? Bailouts, subsidies, and government insurance won't help Wall Street because the Street's fundamental problem isn't lack of capital. It's lack of trust.

Meanwhile, amidst the noise, comes some clear thinking from the New York Sun:

The Treasury Department and the Federal Reserve don't appear to be operating under any clear principles as they go about seizing or saving companies or refusing to...What has become clear is that Mr. Paulson's decision suddenly to seize Fannie Mae and Freddie Mac without so much as a shareholder vote or even a clear capital crisis hasn't exactly inspired confidence in the rest of the financial sector. Rather than stopping the trouble, it spread it, so that Lehman Brothers failed, AIG cratered, and Merrill Lynch ceased to be independently viable.

The Sun goes on to note the imbalance that now exists in the insurance marketplace:

But what does it mean for the rest of the insurance industry that the federal government may now own 80% of AIG? If you are Geico or Aflac or New York Life, how are you supposed to compete with a company that has the power of Uncle Sam behind it?

And finally, after all we've heard about moral hazard (the risk that a bailout will cause others to act without regard to risk thinking, they too, will be bailed out:

And what is the message sent about other big companies in the financial services industry that AIG has qualified as too big to fail? Then the other financial giants such as Citigroup, JPMorgan Chase, and Bank of America almost certainly fall into that category and now become implicitly federally backstopped institutions in their own right.

The Sun is asking the right questions at least. Someone at Treasury had better have good answers.