Given that the Federal Reserve is explicitly tasked with preserving the stability of the financial system, I see no inconsistency whatever in it stepping in to prevent one or other important corner of the financial market from collapsing. I urge you to look for any one statement from Mr. Bernake explicitly saying that he would not do so. In both the supposed cases of “bail out”, Bear Stearn and more recently Freddie+Fannie, it is quite apparent that it was the system that was being bailed out.

I am not arguing that there no consequence of Moral Hazard in the Fed’s (and now the American Treasury’s) actiond; only that time inconsistency does not really model what is going on here.

Given the powerful forces on its side, one may safely bet that the financial system will not be “allowed to collapse” in a manner of speaking. This could hypothetically lead to behaviour where large players take on extremely risky bets since losing those bets impact not merely them but pretty much everyone else as well. They know that while they alone may be allowed to fail, the public will stand by them with the rest of the system. By linking the fate of the system as a whole to theirs, and using that link to as a basis of business policy, they abuse the public good faith.

Perhaps the solution is to engineer a system inimical to large players.