The Hazards of Moral Hazard

Great article in the Washington Post about moral hazard on the anniversary of the collapse of Lehman Brothers. Basically, the government said it wouldn’t back up Lehman and when it didn’t, the collateral damage to the economy was so massive that the government came back, begging for forgiveness, and promise no more Lehmans.

The result? Banks could get riskier than ever. Read the article and more about what moral hazard is on the ol’ Wikipedia, and then suggest what you think the government should do. If it lets banks fail, we could have massive and deep recessions. If it doesn’t, then they’ll carry on with the bubble party because they know there’s a sugar daddy waiting to give them a bailout, no matter what.

23 thoughts on “The Hazards of Moral Hazard

  1. Shaun Jackson

    This article is really shocking because it seems as if there are no effective alternatives to stop the people running the banks on making bad decisions. On all three of the options corruption looks like an easy way of the bank to slide by or the goverment just takes control. There is no escaping the morality problem because there are people that will always do the wrong thing. Greed is one of the “Seven Deadly Sins” and it constantly puts this econmy in a recession and makes things worse off for everybody.Is there really a solution to this problem? what will it enforce and how will it make sure there there wont be excessive risk taking by the bank?

  2. Hugo Espiritu

    It’s kind of like what happened with Solomon Bros. back in the nineties when they were going down for the “bond squeezing” that was taking place. Basically what happened was that the branch of the bank that specialized in bonds would hoard government bonds because they got first dibs. then they would sell the bonds off a little at a time at a jacked up price. In effect the Feds restricted how much a bank could buy to control the unfair play. But that didn’t stop the greedy head bond trader at Solomon. He just used the name of his clients to do the same thing. But things went south and Solomon management tried to cover it up to keep their business affiliates. When the Feds found out they were going to pull the plug on Solomon and bar them from issuing the government bonds which would repel the clientele with a bad rep. Luckily Buffet came in to save the day since he owned it and he made the blow less severe which saved the company and the economy from destruction.

  3. Hugo Espiritu

    It’s kind of like what happened with Solomon Bros. back in the nineties when they were going down for the “bond squeezing” that was taking place. Basically what happened was that the branch of the bank that specialized in bonds would hoard government bonds because they got first dibs. then they would sell the bonds off a little at a time at a jacked up price. In effect the Feds restricted how much a bank could buy to control the unfair play. But that didn’t stop the greedy head bond trader at Solomon. He just used the name of his clients to get a large stash of bonds. But things went south and Solomon management tried to cover it up to keep their business affiliates. When the Feds found out, they decided to pull the plug on Solomon and bar them from issuing the government bonds, which would repel Solomon’s clientele because of the bad reputation that came with being unendorsed by the US government. Luckily Buffet came in to save the day since he owned it and he made the blow less severe which saved the company and the economy from destruction.

  4. Brian Rockwell

    If there is no solution in sight for the greediness of the banking leaders and managers, then the most the government can do is try to limit and contain the bankers to soften the blow of possible economic disasters due to bailouts and bankruptcies. The idea of Resolution Authority has a chance to work if the government can convince banking leaders that they’re serious about imposing “haircuts” on creditors. If they can prove how determined they are to the banking higher-ups, then Resolution Authority could potentially be a huge help for the economy.

  5. Chi Nguyen

    After reading that article, in my opinion, the government needs a miracle of some sort. Letting the banks fail and waiting for someone or something to bail them out are both not such great options. Yes, the second choice would be the best out of the two, but waiting for a bailout may take years and years! Letting the banks fail won’t solve the solution neither.

  6. Emily S.

    I don’t think it is fair to let huge banks fail, because it will cause thousand of people who had nothing to do with the failur to loose thier jobs. There needs to be more than just “incentive” for leaders of big buisness to do the right thing, there needs to be law. People are prone to sin, and As Hugo wrote earlier, all it takes is person to ruin everything.

  7. Ali Aenehzodaee

    To me, the most concrete and least theoretical solution would be to grant the government resolution authority. However, as the article mentioned, this would only work if there was a fear that the government would be willing to slap shareholders on the wrist. The article mentions the FDIC but even they have their flaws. Either way, one solution will create another problem. Either the gov’t regulates business and creates a big bureaucratic mess or the bad guys get away and the greedy stay greedy.

  8. David Truong

    Would it really be that bad if the government regulated business really loosely but strictly enough to prevent corruption and huge bonuses and massive speculation from happening in the first place?

  9. David Liou

    To some people even a little government control on the economy is socialistic.

  10. Alyssa Anderson

    http://www.washingtonpost.com/wp-dyn/content/article/2009/08/27/AR2009082704193.html?hpid=topnews&sid=ST2009090801107

    This article discusses some of the effects of the recent bank bailouts, including the issue of moral hazard. Unfortunately, these bailouts apparently serve only to encourage future risky behavior. The government has shown that they view the danger of big banks failing as more dire than the certainty that those same banks will continue to act irresponsibly. According to the article, large banks have already seen a rise in profits within the most recent quarter while smaller banks struggle. The administration does have a regulatory reform plan in mind that could help control big banks although there are debates about how well this plan would actually work.

  11. Hugo Espiritu

    A good way to make mess-ups stop taking place would be for the government to make it clear to everyone before hand that it’s not going to fix anybody’s stupid mistakes. These banks partake in very risky deals because they know that they can come crawling back. On top of that something about the bad ethics in finance has to be taken care of which is the biggest problem. How do you fix a flaw(greed) in which everybody in the field has and basically needs to thrive in that field?

  12. David Liou

    When the government said they weren’t going to bailout anymore businesses they should have kept along with their decision no matter how much the damage was. They declared that they would help the Lehman Brothers, but ended up helping many more companies afterwards.

    Greed isn’t fixable. But you can take steps to prevent people/companies to not take risks. The government should just ignore the economic sector and focus on getting rid of the national debt. Without government bailouts to fall back on, banks and companies will learn to be less risky.

  13. Hugo Espiritu

    Well greed essentially isn’t bad. It isn’t good either because it’s idolizing money which is pretty stupid considering that as a god money can’t really do much for you when it comes to matters that are more profound than materialistic ones. The bad thing is that people let themselves get carried away by their greed which leads them to hurt others on their never-ending quest to wealth.

    David: Sometimes the government can’t help not being able to not bailout companies. Imagine what would have happened if all the financial pillars that were in crisis in 2008 were allowed to meet their doom. It wouldn’t have been a pretty site.

  14. David Liou

    Letting the economy crash at a later date will be an even more ugly sight, so bottoming out now when the low is still relatively high is better than bottoming out when the worst is much much lower.

  15. deanwebb Post author

    The key, as I see it, is to get rid of the notion of limited liability. If persons cannot be held responsible for the actions of corporations, then corporations enjoy an above-legal status which they can exploit terribly. If major stockholders could go to jail for crimes committed by their corporations, corporations would restrain themselves greatly.

    We’d also see much slower economic growth…

  16. Sagar Patel

    I don’t think there is a way to account for this. I mean in the long run, letting the banks fail would be a good thing because its like a ‘rollercoaster’, the economy has to get better! And if we bail out the banks, the bubbles would continue and our economy would still suck…

  17. Matthew Wong

    The government always pulls banks back out, so the banks do what ever they want knowing that they would still win. but not its starting to be different. banks are going bankrupt, and no one is pulling them back up they had to close down. actually, it doesnt close, but they (the banks) sell their company before going bankrupt, and then the FDIC kicks in to support them. It only goes up to a limit though. Last year, it was up to 100,000 but this year, it will be $250,000

  18. Matthew Wong

    Like Wells Fargo buying Wachovia, and also banks we never hear of, like washington mutual

  19. Hugo Espiritu

    But Sagar, you don’t know when the economy will get better. I sure as heck don’t want to live through a recession my whole life.

  20. David Liou

    But Hugo you can always hope, do you want to live in a world of chaos for the latter part of your life when you’re supposed to be retired, and chillin’.

    The economy will get better if we let banks fail, but people just don’t want to hit rock bottom before the economy gets better. So they stall and buy time by bailing out banks.

  21. Hugo Espiritu

    The effects of the pending consequences of putting off dealing with popped bubbles are going to be worse then the Great Depression if deflation occurs. I would think that would be better later on when I am already established with a job and a home than now because it would make getting a job and a home really hard later on.

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