By Courtney Tower

OTTAWA (MNI) – The “terrible moral hazard” has increased in the
world — with major lending institutions feeling more than ever that
they will be bailed out — Federal Reserve Vice Chair Donald Kohn said
Thursday.

Major lending institutions certainly have to be allowed to fail,
Kohn said in response to questions at a conference at Carleton
University on monetary policy during and since the crisis said, taking
issue with what he said was the position of the Group of Seven.

A way has to be found and is being sought in the U.S. and globally,
between the “two extremes” of letting huge institutions fail or propping
them up, he said.

“You could shut them down and send them to bankruptcy court, which
we tried in September of 2008, and that was a disaster,” he said,
referring to the failure of Lehman Brothers. “Or you could put a lot of
money in and keep it alive, as we did with the AIG two days later, and
that also was a disaster.”

The G7 has said it would not allow any systemically important
lending institution to fail which Kohn said is “not an acceptable
thing.”

“There have to be ways of having failure that don’t undermine the
system,” he said. “But imposes losses on as many counterparties as
possible.”

“Moral hazard has increased tremendously,” he said since the
actions with Lehman and AIG. The world has “moved the dial back on moral
hazard” but reforms now being worked out would make it “quite a bit
less.”

** Market News International **

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