Explicit and implicit bailouts...

Fed and Treasury action over the past two weeks, starting with the announcement that they would be placing the two GSE’s into conservatorship, followed by the decision to let Lehman and Merrill Lynch to their own fates, only to backtrack on a sputtering AIG (once it became all too clear that turning a blind eye in this particular case, with all the counterparty risk, could end up being very costly), and finally announcing a comprehensive bailout plan for the entire economy, has again revived the moral hazard debate.
Suddenly, the point where the line is drawn between what is considered too large to fail and what can be let go of became very blurry and more so with the decision of the Fed to convert the remaining investment banks (Morgan Stanley and Goldman Sachs) into traditional bank holding companies, marking the beginning of a new era.
What was probably not clear with the announcement was that Bank of America's and JP Morgan's purchase of Merrill Lynch and Bear Stearns respectively have pushed the liabilities of these two firms into the same league as that of AIG. So does that mean they are now considered too big to fail? If the markets think so, they could start enjoying lower borrowing costs like those that Fannie and Freddie did. So then the question should be, is the government, with their comprehensive bailout plans, sowing the seeds of future troubles? The answer will depend on how carefully they plan through this very delicate period of reorganization.