Leonhardt digs up an old paper:

The paper’s message is that the promise of government bailouts isn’t merely one aspect of the problem. It is the core problem.

Promised bailouts mean that anyone lending money to Wall Street ranging from small-time savers like you and me to the Chinese government doesn’t have to worry about losing that money. The United States Treasury (which, in the end, is also you and me) will cover the losses. In fact, it has to cover the losses, to prevent a cascade of worldwide losses and panic that would make today’s crisis look tame.

But the knowledge among lenders that their money will ultimately be returned, no matter what, clearly brings a terrible downside. It keeps the lenders from asking tough questions about how their money is being used. Looters savings and loans and Texas developers in the 1980s; the American International Group, Citigroup, Fannie Mae and the rest in this decade can then act as if their future losses are indeed somebody else’s problem.

Dave Schuler responds:

We’re left on the horns of an awful dilemma. Either we must prevent financial institutions from growing to this sort of size and power or we must be prepared to deal with the consequences of financial institutions that are beyond the power of national governments to regulate and, as Mr. Leonhardt recounts so frighteningly, have every incentive to loot the national wealth of the countries in which they operate.

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