Moral Hazard: The Real Culprit of the Financial Crisis
There has been a great deal of finger-pointing going on.
Who is to blame for this extraordinary crisis? Arguably, it is the most personal of the many crises visited upon us in my lifetime and probably the most far-reaching since, as of this morning, it had engulfed most of the world. Congress and the American people are looking for a "villain" or "villains" -- someone or some group that can be tagged with the blame for what has happened to the world economy. Wall Street's investment bankers rank high on that list. Driven by greed, they couldn't have cared less about the corporations which employed them and the customers who sustained them. Government, and central banks, come in a close second. Regulators failed to do their jobs and the central banks simply fed the credit bubble without regard to the consequences. Others tag individuals like Alan Greenspan, Ben Bernanke and George Bush. I could go on with the various candidates in the blame game but it diverts me from my point.
The fact of the matter is none of this really hits the mark. The real culprit is an idea -- a bad idea, one that has gripped the advanced societies since the introduction of Franklin Roosevelt's New Deal, the federal government's response to the Great Depression. The words which encompass that idea most closely are "moral hazard." When we hear those words we immediately think of the Wall Street financial houses and funds in their relationship with the government. What we do not generally compute is that moral hazard applies to the rest of us as well.
Moral hazard is the state of mind created by a belief that the government is going to bail us out if something goes wrong -- in our lives, in our economy. How many of us assessed the spreading damage of the credit crisis and said to ourselves, "the government will step in and take care of it"? How many of us believe that the government will somehow bail us out personally, or as a society, when things go bad?
The answer to that question is "almost all of us." And this goes for Wall Street's masters of the universe as well. It should not escape our notice that when the chairman of Lehman assigned blame in Congressional testimony yesterday, he noted that his firm did not get the same bailout that others did. In other words, if only the government had stepped in, Lehman wouldn't have collapsed and the hearings being conducted yesterday would have been unnecessary.
But you see, this whole idea of personal and public bailouts is what is behind the problem in the first place. As long as institutional man believes that the government stands behind him no matter what level of risk is taken, the level of risk will rise to the point failure is imminent. Why not swing for the fences? Win and you take home the prize. Lose and the government covers the losses. Such a philosophy makes for bad decisions. We have seen the net result of such thinking over the past several months, and it isn't pretty. It is what led millions to take on mortgages they couldn't afford; it is what drove Wall Street to take risks it couldn't possibly cover.
As for individuals, over the past few weeks, as the crisis went into high gear, in my daily travels I heard over and over again, "How could this be happening? This is crazy. I have never seen anything like this." The prevailing attitude was one of disbelief. That somehow, someone, somewhere should have seen this coming and headed it off; that is, made sure it didn't affect the rest of us. When Congress failed the first time to pass the TARP legislation (which is probably the biggest underwriting of the moral hazard mindset since the Roosevelt administration), most could not believe that they hadn't passed the legislation. After all wasn't "this sucker going down" if we didn't (as our president so succinctly put it)?
So you see, my friends, it is an idea which got us here, not an individual or group of individuals. And it is this same idea which has driven this government to the next level of socialist engineering, and driven us deeper into the socialist embrace. In the end it comes down to a question of honor, morals and ethics -- our institutional approach to the human condition. As a society, we can encourage bad behavior or we can discourage it. We have chosen to encourage it. Politically, in our desperation to help, we only hurt, because we damage our own characters.
So the road to the big bailout of 2008 is paved with an idea -- the idea that we don't have to be 100% responsible for our lives, or our institutions, because a great safety net lies below us. It is a breeding ground for bad decisions, and it doesn't end here with the big bailout of 2008. As I said in my earlier essay, this is more of a beginning than it is an end.
I have hinted at this human aspect to the economic predicament over the years, and attempted to explain that there is no perfect economic system, just as there is no perfect human institution and, certainly, no perfect human being. And that is where gold comes into the picture.
Gold is the remedy when things go awry simply because it is the one primary asset that remains fundamentally detached from the political economy. At the same time, it still serves its holder as a usable, identifiable and valuable asset within that system. That sentiment has caught hold globally and in America over the years, and even more so over the past year as the smoldering heat underneath the world economy achieved full combustion. Some have taken to heart my message on gold, and they have done well as a result. Better put, gold has done for them what it is billed as doing -- helped them ride out the storm.
There is a message in that which should be taken to heart by those who do not own gold. If you think that gold's best days are over, then you don't completely understand why gold should be owned in the first place. It is still, first and foremost, an insurance policy against events like the ones which have occured over the past several weeks. It is not, in the first instance, an investment.
America's chickens have indeed come home to roost, and with a nasty vengeance. The government, in response, has gunned the engines of the money making machine, and created a new bureaucracy to deal with its toxic waste. Unfortunately, there are those who will be blinded by the bright lights of the government rescue and come to believe that the worst is over. They will make their financial plans accordingly. That, in my view, is a mistake.
The worst is not over, and it is not over because the ultimate causes of the problems which launched the meltdown have not been restrained. In fact they have been radically unleashed with perhaps even deeper consequences, including the looming possibility of a runaway stagflation.
If you take one thought with you from this short essay, let it be this: As long as the sort of thinking described above persists, gold will remain the asset for all seasons, all economies, all possible misadventures. Richard Nixon, upon detaching the dollar from gold and letting it float in 1971, famously proclaimed, "We are all Keynesians now". He knew running deficits and underwriting what we have come to call "moral hazard" would now have no deterrent. Would he say, after these past ten days' events, that "we are all Socialists now"?
If so, a stronger case could not be made for gold. As one astute London trader put it many years ago: "Gold is bedrock."
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This article has 9 comments:
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Lawrence Kramer
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21 Comments
Oct 15 08:09 AMMoral hazard is an enabling condition, perhaps, but the immediate culprit is the ratings agencies who had no skin in the game: having no risk to be insured, they had no moral hazard in their decision-making process.
But the immediate cuprit is usually just the weak link in a chain that has come under tension; the tension on the chain that is the "real cause" of the crisis. In our case, the tension was the trade deficit. The deficit made it necessary for us to provide a home for the dollars we spent on imports. Where else were they going to go to make them worth having? We had to borrow them, but Pres. Clinton balanced the budget, leaving the private market to supply the paper. The rest is history. Even the burgeoning Iraq-based deficit could not keep up with the inflow of money. Only by lying about the value of collateral could we accommodate the deluge of petrodollars. So we lied. What else could we do? Conserve energy? Use natgas or nuclear energy? C'mon, this is America!
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dmh00000
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2 Comments
Oct 15 08:14 AMSo the periphery sitters have two choices, let the players build and grow their business (and make a lot of money) or get in the game (and take some of that business). It’s in the latter decision where the bubble gets created, logic is abandoned and a period unwarranted capital allocation proceeds. The periphery sitter doesn’t care if their involvement will create the bubble or if it will create a bubble, exacerbate a burgeoning bubble or if, in the long run, it will ultimately lead to capital destruction. No, the periphery sitter only looks at its own survival and concludes if I don’t get in the game, new wealth may get concentrated in the hands of players that may seek to diversify their lucre into my business.
It is precisely when the periphery sitters enter the game when the bubble potential is heightened and most vulnerable. (The size of the bubble will be a function of the added production capacity the periphery sitters add to the market when they join.) Few industries can, effectively, double or triple their capacity and get the same returns as the players were getting when the capacity was much smaller; yet that is exactly what we see in each bubble. (Because Wall Street has virtually unlimited access to capital, it’s easy to see how their movement from periphery sitter to primary player can dramatically change the capacity for any industry they decide to throw capital at. The 2000 telecom bubble had the same problem. Tons and tons of new capacity were brought on line by Wall Street’s unchecked easy money policies towards telecom carriers that lacked the requisite demand to absorb the new capacity.)
So why does Wall Street, in the most hackneyed of clichés, throw good money after bad? Is it because they don’t understand the risks? Is it because they don’t understand the industries they’re investing in?
It seems unlikely that Wall Street doesn’t understand the businesses they invest in. After all, they hire the best and brightest from inside the industries they look to invest in supported by the best financial minds their money can buy.
The problem is more fundamental than that. It’s fear, jealousy and the expectation that when reality catches up to fantasy, everyone will fail. Blame will be evenly distributed among all players. Depending on the size of the bubble some companies will fail and in the case of the most recent bubble, even some Wall Street firms will fail. But in the end, since everyone is to blame, no one is to blame.
The aftermath is ugly, but the gun is already reloading for the next bubble.
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renochang
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1 Comment
Oct 15 10:38 AMDon't mean to be cynical, but every time I think about our leadership - all makes and models included - the term GIGO (Garbage In, Garbage Out) comes to mind. We are who we are, and we reap what we sow. The outcome is entirely expected.
But we still have our nukes. So when the world stops lending to us, we'll just have to start robbing them at gunpoint: what we can't pay for with our MasterCard's, we'll just have to pay in blood.
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CrisisTheory
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13 Comments
Oct 15 05:41 PMUnfortunately, one of those "bad decisions" bred by living with the "saftey net" of government, civilization, the feared 'collectivist spirit', was the decision to attempt the utopian lunacy of the "free market" to regulate conduct in human society.
This (2nd) great experiment in "market fundamentalism" - the impossible belief that there ever was, is, or could be a "free market" and that such a construct should serve as the highest arbiter in the organization of society - inaugurated by Regan, Thatcher (and Deng), has collapsed of its own contradictions.
Just as the 1st great wave of market fundamentalist liberalization ended with the implosion of the international system, world wars and depression- leading the great economist Karl Polanyi to declare that humanity had forever learned the error of the utopian idea of the "free market"- so do some now claim that we have learned our lesson.
Yet the author is proof; for beleivers in the creed, only a more pure imposition of the system could have avoided the crisis; the madness of Austrians.
Profit cannot be the supreme value in social organization; governments that attempt to implant systems based on this premise merely sow the seeds of disaster.
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wdhalgren
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17 Comments
Oct 16 09:26 AM-
BrunoT
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70 Comments
Oct 16 12:01 PMThink we're not a nation that tolerates dishonesty? Go flip on the radio and listen to just about any advertisement, be it for weight loss powder or get rich quick schemes. We know this dishonesty and unprincipled behavior goes on constantly in almost every phase of life, but we tolerated it. We tolerated it because we thought if it made or saved us a little extra money it would be ok. And now it's not ok.
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User 232593
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61 Comments
Oct 16 12:35 PM-
usslbcgn9@earthlink.net
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163 Comments
Oct 16 12:55 PM-
Diegojames
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83 Comments
Oct 17 02:28 AMSociety(people) BUY what is good for them if a company is smart to find what people need rather than what they and government can fool them into accepting or fooling people to buy into.
Got it?
Diego
Hint: in southern California there is alot of sun all year long and we need energy.Divert government tax money in this direction and move corporations into this area by FORCE if needed. I do not need a CELL PHONE AND another stupid tv show about hollywierd.Along list of BS in our society can easily be formulated.