Moral Hazard Is for Suckers

Last summer, while sitting on a beach, I overheard a father tussle with his young son about whether the child was old enough to take out a small sailboat. The father finally relented. "Go ahead, but I'm not gonna save you," he said, picking up his newspaper. A while later, the sailboat tipped over and the child began yelling for help, but his father didn't budge. I put down my book, walked over to the man, and delicately told him his son was in trouble. "That's okay," he said. "That boy's gonna learn a lesson he'll never forget." I walked down the beach to notify a lifeguard, who promptly went into action.

Letting children bear the consequences of their risky behavior -- what some parents call "tough love" -- can be applied to adults as well, and conservatives have made a virtual fetish of it. A few weeks ago, as George W. announced a paltry plan to help out a few of the millions of homeowners who got caught in the sub-prime loan mess, he reiterated the credo: "It's not government's job to bail out ... those who made the decision to buy a home they knew they could never afford."

People do tend to be less cautious when they know they'll be bailed out. Economists call this "moral hazard." But even when they're careful, people cannot always assess risks accurately. Many of the mostly poor home buyers who got into trouble did not know they couldn't afford the mortgage payments they agreed to. The banks and mortgage lenders that pulled out all the stops to persuade those home buyers to the contrary were in a far better position to know. So were the credit-rating agencies that gave these loans solid credit ratings, as did the financiers who bundled them with less-risky loans and sold them to other financial institutions.

The real moral hazard in this saga started when Federal Reserve Chairman Ben Bernanke cut the Fed's discount rate (charged on direct federal loans to banks) and announced that the Fed would take whatever action was needed to "promote the orderly functioning of markets." Translated, this means that lenders, credit-rating agencies, financial intermediaries, and hedge funds will be bailed out, one way or another, because they're simply too big to fail. Note that behind every one of these institutions lurk thousands of well-paid executives who would have lost big if the Fed hadn't come to their rescue. Even though they had more information and experience at risk-taking than the suckers who borrowed their money, moral hazard doesn't apply to them.

When big entrepreneurs take big risks that fail, it's amazing how often they get bailed out. The history of modern American business is littered with federal bailouts, loan guarantees, and no-questions-asked reorganizations: the Chrysler bailout of 1979, the savings and loan bailout of 1989, the airline bailout of 2001. Most bailouts, however, occur in the relative dark, such as the 1998 rescue of giant hedge fund Long-Term Capital Management, the not infrequent bailouts of under-funded corporate pension plans by the government's Pension Benefit Guarantee Corporation, price supports for big agribusinesses facing market downturns, or the current bailout of Wall Street being engineered by Bernanke's Fed.

CEOs get away with stupid mistakes all the time. Some, like Robert Nardelli, the former CEO of Home Depot, drive their company's stock so low that their boards eventually oust them. But they leave with eye-popping going-away presents nonetheless. (Nardelli got a $210 million severance package.) If you're an average American who gets canned from your job, even through no fault of your own, you probably won't even get unemployment insurance (only 40 percent of job losers qualify these days). Conservatives tell us that unemployment insurance reduces workers' incentive to find a new job quickly. In other words, moral hazard.

Some CEOs use bankruptcy as a means of getting out from under pesky labor contracts. Others use it as a cushion against bad bets. Donald ("You're fired!") Trump's casino empire has gone into bankruptcy twice with no apparent diminution of the Donald's passion for risky, if not foolish, endeavor. After all, his personal fortune is protected behind a wall of limited liability. But if you're an ordinary person who has fallen on hard times, just try declaring bankruptcy to wipe the slate clean. A new law governing personal bankruptcy makes that route harder than ever. Its sponsors argued -- you guessed it -- moral hazard.

The little guys get tough love. The big guys get forgiveness.

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