The central problem with the Wall Street bail outs is something called "moral hazard."
Friday, September 19, 2008
Moral hazard problems arise when actors know they will not have to suffer the costs of risky behavior. Free market based criticisms of the IMF argue that when the IMF rushes in to save banks from financial crises in developing countries, the IMF is encouraging a moral hazard problem.
The current banking crisis has its roots in a moral hazard problem. As Dr. S. neatly summed up in his early comment bankers "were perfectly responsible and rational. They knew they would get rich when the big risks worked out and would get bailed out when they did not."
Now you might say that individual mortgage borrowers were also investing under a moral hazard situation. But can we really think that a blue collar home buyer with questionable credit really expected to be bailed out if they couldn't make their house payments? No. I argue that the reason those people took excessive risks was that they were deliberately mislead by the banks and encouraged to take greater risks with promises of a never ending housing boom.
And this leads us to morality. We have a situation where the banks knew that THEY would be bailed out if they wound up with great piles of bad debt. But they did not fully inform the home buyers of the risks to anyone. Instead they relied on their privileged knowledge of government intentions and policy possibilities to aggressively encourage people to take enormous risks that would only serve to benefit the bankers.
I wonder what the so called Christians who love Sarah Palin so much would think of that kind of behavior.
Posted by Raised By Republicans at 9:27 AM