A lot has been made of the lack of moral hazard on Wall Street, festering into the current crises.

Michael Lewis, author of a number of great books, including Liars Poker comments in his recent column titled: Bright Side of a Total Financial Market Collapse:

>No sooner did Greenspan shuffle off the stage and sell his memoir than the financial system he helped shape fell apart.

>He’s left not only a mess but a void. No matter how well- educated we become in our financial affairs, we still need public officials to look up to, unthinkingly.

Slate’s new The Big Money is an excellent resource for financial news commentary. Martha White’s article: What Is a Moral Hazard? The economic reasoning behind bailout or no bailout is a good read.

>While bailout seems to be the financial term du jour, right behind it is the more ambiguous “moral hazard.” Treasury Secretary Henry Paulson cited moral hazard as the reason not to swoop in to save Lehman Bros. and Merrill Lynch. Puzzling to many, though, was that while moral hazard was discussed in conjunction with the rescues of Bear Stearns, AIG, Fannie Mae, and Freddie Mac, it wasn’t a deal breaker in any of those cases.

>…moral hazard is the idea that insurance in any form makes people riskier.

When I was 15 years old back in the Bicentennial summer of 1976, I rode my bicycle 4,400 miles zig zagging across the US with a group formerly called Bikecentennial. Of 4,000 people who participated, 3 people actually died riding that summer, and within our own group of a dozen riders, those who did wear helmets experienced wrecks and those who didn’t wear helmets (like me), were fine.

I often wondered if wearing a helmet made the riders more prone to take risks. I don’t think so – they represented a cross section of temperaments in our group. In fact, I bought a helmet when I got home and have worn one ever since – and no wrecks.

Perhaps it is more as an argument of convenience. Throw it in if it helps make the case?

The absence of moral hazard of the current situation was created by the GSE structure to begin with. Investors assumed the US would bail out ‘Mac & ‘Mae if they ever ran into trouble because they were “government sponsored”. I can only imagine what would happen to the financial system if the former GSEs were allowed to fail. “Faith and credit of the US” would have meant nothing forever, or at least as long as the current Yankee Stadium is old.

And the system seems to be unraveling quickly judging by more actions this weekend.

Paulson and Bernanke have been making moves faster than Congress or the President can seemingly comprehend. Expect Congress to start fighting the changes once they get it.

>”There are no atheists in foxholes and no ideologues in financial crises,” Mr. Bernanke told colleagues last week, according to one meeting participant.

A bit unnerving but the Bush administration has been disconnected from the crisis until a few days ago, when it began to back Paulson’s actions. In fact, that was a requirement of Hank’s acceptance of the position to begin with, unlike his predecessors in the current administration.

And the candidates, until a few weeks ago, didn’t discuss the issue directly – and still don’t seem to get and at the very least, didn’t see it coming. Paulson and Bernanke need to move fast.

The lesson learned from this bailout of epic (trillions) proportions, was best said by Floyd Norris in his Reckless? You’re in Luck

>If an activity is important enough to justify a government nationalization to prevent a default, it is important enough to be regulated. The regulators need to know what risks are being taken, and by which institutions, in time to act before a crisis develops.

>Had the government bothered to do that in years past, it might not have faced the decisions it faced this week. First, it let one big firm go down, and then it became scared enough to nationalize another one to keep it afloat.

>Now, showing no sign of embarrassment over how badly they failed before, the current crop of regulators seem to be unified in their determination not to let the markets force them to make a similar choice on some other big financial institution.

It’s not about more regulations, its about regulations that deal with today’s markets.

Paulson and Bernanke will have to wrestle with these issues later, right now, they are suggesting we all wear a helmet.


  1. Edd C Gillespie September 22, 2008 at 1:56 am

    Regulations, deregulation, new regulations different regulations, updated regulations, what are we trying to do? Make these bankers worthy of the public trust or protect the public from them? They have clearly demonstrated they consider themselves to have no responsibility for anything other than their own profit in the moment. And they will lie to do that. I guess the politically correct term for what they are doing is now called lack of transparency. I’m reminded of pigs and lipstick.
    Do you think congress will try and represent us taxpayers in this thing? Seems the last five administrations have forgotten to do any of that sort of stuff. Oh, I know Paulson and the Bush (the President with the deer in the headlights look) said they needed to move to protect the consumer from something worse than paying the banks hundreds of thousands of dollars. Yeah right. We need a government to protect us from the government we have. How much does that cost?
    I got a solicitation from the Obama campaign on Friday. I wrote back and asked if Obama had any kind of a specific plan to deal with all of Bush’s new purchases. Not fair to ask. The guys in the Whitehouse now, and apparently no one else, have no idea what is going on or what happened. So how can anybody possibly deal with it? Bush actually said, “It turns out the economy is all interconnected.” Where did this guy come from? That is undergraduate Econ 101 and he amazingly just now learned it. Seems the most significant aspect of the crises might be that Bush had to postpone going to Crawford. I have no idea why he didn’t go ahead. He is of no assistance in crafting a solution. Maybe they need him to sign something or notarize it.
    There is no one in charge guys. No one. Not even Cheney. He just disappeared for this one. And it looks like that is the way it will be for quite a while. Ron Paul or even Ralph might have chance.

  2. JDallas September 22, 2008 at 11:15 am

    I believe this is the epitome of a moral hazard. When you see people making decisions without respect to the greater outcome, but only with the idea that they will get bailed out you end up with cases like the one we are in. Now let’s think, many of these companies that were bailed out are also looking to be bought. So if company A cannot be allowed to go under cause it will destroy the economy, then why will company A merged with B be allowed to go under should they make the same mistakes in the future.

  3. Michael Daly September 22, 2008 at 8:05 pm

    My, this has been an epic experience, hasn’t it? If we looked at history, we would see this pattern repeated; the Roaring 20’s, the Gordon Gecko years, even in the bible.
    We can’t help but get carried away and “let the good times roll”. It’s human nature. So, unfortunately, is greed. The mixed potion of greed and prosperity boils the smiling frog slowly. It’s like being in love/lust. My friends and family tried to warm me (both times), but did I listen?

    So much of what now looks like moral hazard, only a few short years ago seemed like the “way of doing business”. Pull money out of the house? Sure, we’ll flip it and cover it in the re-fi. Give ’em the “no-doc 90-10 product”. Oh, ok…

    Everybody’s doing it! No excuse…none whatsoever. The wet blankets who predicted this for years have gone from being Sorcerers to Socrates, enigmas to Einsteins.

    There’s no use in laying over and dying. It’s time to pick up the pieces and rebuild. No point in hand-ringing about whose fault it is, either. It’s time to vote in the people we believe can lead us forward. If there’s no one who can do it on the ballot, then find her/him and get ’em on the next one.

    Today’s a new day. Stop whining and get to work…contribute to the greater knowledge wherever we can (like Jonathan does everyday)…we’ll be fine.

  4. Ki September 22, 2008 at 9:25 pm

    I think short term some of the bailouts have made sense. Long term we are simply teaching them that if things go bad they will get bailed out. And this is basically teaching CEO’s to utteryly ignore risks. So it would not be surprising if we end up in the same situation soon. I think when a bailout happens the first thing we should do is sieze the CEO’s salary for the last year for being so reckless.

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