The recent proposal, reported in various places, to have the Fed buy unsecured short term debt seems a textbook example of creating moral hazard:
Last night, the Fed was drawing up plans to set up a special fund that would buy short-term commercial paper. The purchases would benefit banks as well as non-financial companies.
The fund would be financed by a loan from the Fed, and any losses would probably be covered by the Treasury using its new $700 billion bailout package. Fed and Treasury lawyers were hammering out details last night.
Purchasing commercial paper through the new special entity would increase risks for the Treasury, and ultimately taxpayers, while potentially relieving companies of the downside risk of bad behavior, financial experts said. One senior U.S. bank executive said it was “like taking the fire sensors out of the building.”