Moral Hazard
Back in Switzerland, one event I went to was sponsored by the Geneva Private Bankers association. They said that though their investments were down somewhat as a result of the crisis, they had avoided any kind of catastrophe. And the reason they avoided catastrophe, they said, was that Swiss private banks are unlimited liability partnerships. And that, they said, makes them risk averse. This is somewhat similar to the conclusion Michael Lewis reaches at the end of his entertaining and informative Portfolio article on the situation in which he suggests that the transformation of Wall Street firms from partnerships to public companies played a big role in the crisis.
That said, while you might have been able to prevent the emergence of large, publicly listed financial services firms now that the cat’s out of the bag it’s not clear to me how you would put it back in. And there are advantages to letting finance firms get big and capture some economies of scale. But I do think some of the moral hazard issues involved in this bailing out business have been getting short shrift.
Megan McArdle’s made to me the case that the movers and shakers on Wall Street have taken a bath on all this and are plenty sad as is. But I don’t think that’s quite right. For one thing, if you had $20 million stashed away somewhere and lost 95 percent of that, sure you’d be pretty sad. But you’d still have a million bucks in the bank which is a lot more than most people. And what’s more, during the fat years you’d been enjoying very high ongoing levels of consumption. Merely losing most of your savings doesn’t come close to making the overall experience a negative one — you’d need to be brought down to less than zero to make up for those years worth of high on the hog consumption slows. Specifically, to distinguish the issue at hand here from a pure quest for revenge, we need to ask ourselves what the current state of play make a titan of finance think about the way he’s been running his business. What you want is for people to look back and say “well, I wished I’d managed the firm more responsibly at the margin.” But I’m afraid the real retrospective analysis is “well, I wish I’d managed the firm less responsibly and soaked up more leverage-laden profits back when the going was good — after all, the whole thing was going to blow up anyway and I was going to come out ahead anyway.”
The conversation has sort of moved past this moral hazard point, in favor of discussion of regulatory changes. If you’re going to have bailouts, the thinking goes, then you need to have preventive regulation to make sure this doesn’t happen again. And that’s fine. But I think the more you look into this, the more pessimistic you become about the idea that we’re ever going to construct a really airtight regulatory regime. My joking proposal at dinner last night was that you let firms operate totally unregulated, but with the proviso that if your company winds up needing a bailout at some point we’ll take your family out back and shoot them.
Now, admittedly, you probably can’t do that.
But you probably can’t prevent bubbles and manias and panics either. And you probably can’t let everything fall apart just for the sake of teaching some folks a lesson. But you can try to prepare better for cleaning up the aftermath. And it seems to me that it’s essential that part of that be making people really pay a price. Not just losing a lot of money, but actually winding up worse off than they would have been if they’d never gotten into the game in the first place. Ultimately, I’m not sure that all the regulation in the world can really make up for the simple idea of caution.
66 Responses to “Moral Hazard”
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November 19th, 2008 at 12:22 pm
But I think the more you look into this, the more pessimistic you become about the idea that we’re ever going to construct a really airtight regulatory regime.
The root of the present crisis seems to be more about having no regulatory regime at all. Suggesting that making the traders more personally liable for losses would help prevent future bubbles seems akin to advocating the death penalty as a deterrent to crime.
November 19th, 2008 at 12:23 pm
Or we could happily resign ourselves to bailing people out every so often, with funds we raise from much higher tax rates. Lots of moral hazard, but they’d be paying for their insurance.
November 19th, 2008 at 12:25 pm
Matt . . . You are correct in that the Wall Street “movers and shakers” are – by and large – just fine financially.
Thanks, in no small part, to Hank Paulson. He bought them enough time to get most of their money out. The real “movers and shakers” are now sitting on the sidelines – waiting for the right time – to get back in and make another killing.
The $30 million apartment and art sales will rise again.
November 19th, 2008 at 12:25 pm
I actually like Matt’s idea, except instead of shooting their families, you could allow the government to just wade in and take everything over, with no compensation to anyone. You’d have to figure out when the government will pull the trigger, but essentially investors (both stockholders and creditors) would go in knowing that this could happen, so their investments would be subject to this threat and the managers would have to pay high interest or convince investors that the thing will be properly run.
Okay, okay, we can do all that and shoot the families.
November 19th, 2008 at 12:30 pm
You need to add a McArdle tag so at some point in the future I can go back and look at all the stupid stupid things she’s said to you.
November 19th, 2008 at 12:30 pm
The 19th Century saw a whole string of financial panics back at a time when there was no gov’t bail-out moral hazard and in fact no social safety net of any kind. Bankers were well and truly “ruined” back then. It didn’t stop the regular financial boom-and-bust cycle. The nature of competition in banking is such that everyone has the incentive to take on a little more leverage, a little more risk, in order to stay ahead. Free markets will not restrain this behavior any more than they will keep melamine out of infant formula. Regulation is required. This is not to say that bankers should not _also_ be ruined… but it is not sufficient to stop financial crashes.
November 19th, 2008 at 12:33 pm
Japanese executives whose companies/institutions fail occasionally commit seppuku. That’s probably an extreme sense of morality no Wall Street executive would ever exhibit, but a little bit of remorse and a refusal to accept year-end bonuses for leading the company down a rathole would be great PR.
November 19th, 2008 at 12:34 pm
Stop privileging capital gains income and tax it the same rate as wages. The tax code actively encourages investors to sink their cash into financial markets instead of actually trying to produce anything useful with it.
November 19th, 2008 at 12:36 pm
Please, stop! Wow, you can’t make air-tight regulations??? Why, news like this is astonishing, it is e=mc2 genius!
If you are going to make the libertarian turn, fine, but to make the libertarian turn by taking on Megan McCardle’s ideas and style is painful.
I wonder what great economic discoveries you all will make next. Hey, how about this. Not every business makes a profit. Thus, there’s no airtight way to make a profit and free enterprise is doomed! Also, consider the deep consequences of this: all men are mortal. Makes you think, doesn’t it.
When the wisdom is tossed around the table in D.C., obviously, the sky is the limit.
November 19th, 2008 at 12:36 pm
Buried in this long post is a useful insight, but you have to wade through two bits of incredibly sloppy thinking. The insight is that a limited liability corporation is an artificial entity, created by law, and thus by social agreement, with public and social consequences. Moreover, any bailout is a political and social action, with consequences for all of us as well. In exchange, we should therefore think of who benefits, what punishments are proper, what regulation is proper, and when the tendency toward consolidation and monopoly makes antitrust laws imperative. The whole idea of a free market is a sham, even if it really did work to maximize everyone’s benefit, which is a myth.
The main content, however, is silly. First, Matt suggests that nothing short of the risk of losing all one’s money would discourage a manager or investor from self-serving but poor decisions. Surely if that’s true, any investor is not at sufficient risk, meaning pretty much any of us. Surely, too, we’d then wish to abolish bankruptcy laws totally and cheer on that horrible bankruptcy bill (which certainly influenced my vote against Clinton in the primary). We wouldn’t dream of worrying about tempering the consequences of the present disaster to anyone, including home owners. We’d think our own losses to date don’t matter. We’d abolish fines for criminal acts or civil damages, as pointless.
The second inanity is to single out the partial shift in one industry to corporations. Ok, so this time it was some brokerage firms and financial institutions, some of which weren’t corporations before and some of which are now. Does that mean other corporations, such as the auto industry, also don’t make idiotic decisions? Should we just abolish corporations entirely, then?
November 19th, 2008 at 12:36 pm
“But I think the more you look into this, the more pessimistic you become about the idea that we’re ever going to construct a really airtight regulatory regime.”
OF COURSE we’re never going to construct an airtight regulatory regime. That isn’t the purpose of government regulation and never has been. The purpose is to set ground rules that foster good business practices– practices which reduce moral hazards, foster healthy competition, keep fraud and insider trading to a minimum, and reduce negative externalities.
Disingenuous hand-waving about the possibility of airtight regulation, coupled with cynical suggestions that we’d be better off with no regulation at all, has been the essence of the conservative project for the past 75 years. And look where that gets us.
You really ought to start giving McArdle the O’Hanlon treatment. Whenever she makes a suggestion about financial policy, you should probably do the exact opposite.
November 19th, 2008 at 12:38 pm
One problem is that the people who will pay the price for failure might not be the same people who are going to be running the next global economy. The people in charge during the next boom will be a new generation of young go-getters and upstarts, with the same impetuous drive to make a fortune, but without the memory of pain and loss.
I haven’t the expertise to say anything about specific regulations, but it seems to me that the systematic problem is that we currently have a set of market rules that encourage far too much risk and too much leverage altogether, and that we need to re-direct things in the direction of greater overall market sobriety, with fewer go-go booms and windfalls, perhaps, but also fewer crazy bubbles and out of control pyramid schemes.
It also seems that we need to keep risk closer to the source of the entity that has taken the risk, and be somewhat less tolerant of risk being pawned off, in ever more opaque layers, to others. The instruments that allow risk to be chopped up and re-distributed smoothly throughout the economy, while supposedly serving as a kind of insurance plan, also allow important and reliable information to be diluted and lost in every chopping up. The result was catastrophic loss of information in which there was a deplorable economy-wide deficit in knowledge about the value of one’s assets, and the result was something like a pyramid scheme in which the value you attach to your assets floats increasingly free of the economic foundation on which they ultimately rest, and is increasingly derived solely from your subjective assessments of your ability to convince others to buy them from you.
November 19th, 2008 at 12:40 pm
Megan McArdle’s made to me the case that the movers and shakers on Wall Street have taken a bath on all this and are plenty sad as is.
Wow. Doesn’t Megan see that Wall Street intentionally works with boom and bust cycles to make obscene profits. Just in the last decade, there have been two majors- Internet and Real Estate. For each one, there are years of ridiculous profits followed by a bust. And that produces an end result of still obscene profits. Maybe the real estate bubble burst was worse than expected, but it was expected with minimal economic analysis, certainly enough so to hedge against its possibility.
November 19th, 2008 at 12:46 pm
well, I wish I’d managed the firm less responsibly and soaked up more leverage-laden profits back when the going was good — after all, the whole thing was going to blow up anyway and I was going to come out ahead anyway.
If people actually thought what they were doing was unsustainable and irresponsible they could make a lot more money being “responsible”. I remember a few guys who even made a couple billion betting the housing market was overvalued.
Of course rich people don’t care about making money because they are rich and rich people don’t respond to free market incentives. That is why we need someone like Matt to arbitrarily impose punishments on those he sees fit (perhaps we could even vote on how much they should suffer).
November 19th, 2008 at 12:54 pm
“…I think the more you look into this, the more pessimistic you become about the idea that we’re ever going to construct a really airtight regulatory regime….”
No matter how good the “regulatory regime” is, it won’t matter as long as the pols who run the regime are paid off by those being regulated. Bill Moyers said Obama’s biggest campaign contributor was the financial services industry. And when you look at where people like Dodd, Frank, etc. are getting their $$$$….. I’m not sure how much change we’re going to get here.
November 19th, 2008 at 12:54 pm
That is why we need someone like Matt to arbitrarily impose punishments on those he sees fit (perhaps we could even vote on how much they should suffer).
That’s a good one. Good thing we were able to impose cash infusions to insolvent companies. That taught them.
November 19th, 2008 at 12:56 pm
From the illustration, I see that Matt knows where the saying “cat’s out of the bag” really comes from.
November 19th, 2008 at 12:59 pm
Having been through this a couple of times I can say that for many privately held companies, the management spends every waking hour figuring out how to “get liquid.” Getting liquid is a euphemism for having an IPO which allows the equity owners to transfer their enormous undiversified risk from their own shoulders onto the new stockholders. In the process they trade their risky equity for cash. They no longer lie awake nights worrying about dying broke. After the IPO there is a palpable change in risk management. You’ve made you lifetime pile that can’t be taken away. The old game was don’t screw up. The new game is that you get these free stock options every year and you may as well bet them all on black at the roulette table.
November 19th, 2008 at 12:59 pm
Which is why I think we should give 25 bill. to Detroit with few strings attached; hopefully, it will regroup, come around and we will get repaid; but if you doubt Detroit going under will cost us less than 25 bill- I have a bridge to sell.
November 19th, 2008 at 12:59 pm
But you probably can’t prevent bubbles and manias and panics either.
Hrmm. Destruction of the Continetal plus depression, 1776-1788 or so, Panic of 1819, depression of, oh, 1836-1844, Civil War, Panic of 1873, Long Depression of 1873-1896, Panic of 1893 (and follow on of 1896), a brief mini panic in 1901 (I think), panic of 1907, banking crises of 1910-1911, micro-depression of 1920-1, the big crash of 1929, Great Depression, Stock market bubble & panic of the middle 1980’s, real estate bubble of the late 80’s, (big recession of the early 1990’s), stock market bubble of 1999, (recession), real estate bubble, market panic of 2008.
Ooo. I forgot the banking panics of 1792, 1797, 1825, 1847, 1857 and 1866.
See that big hole in the middle there between 1941 or so and 1984 or so? Yeah, not so much with the panics or bubbles.
I’m not sure what this McArdle thing is about Matthew: panics and bubbles have been prevented (or at least severely constrained). Whereas when we adopt the ‘very sad executive’ model of banking collapse, it just keeps getting worse. I am kinda getting the idea that you accept the glee-bertarian idea that no regulation can be done so no regulation is worth doing. (Curiously, the banks will still need the government to supply them with money.) In which instance, I assume you really want to adopt Ron Paul’s tactic and go back on gold or silver and simply accept banking crises with no bailout, We can do that, but it’ll be crashy.
max
['Or you could refuse to accept the notion because it's wrong. Your choice.']
November 19th, 2008 at 12:59 pm
Maybe we should think about building a financial services industry in which people simply can’t make so much money, and don’t have the structure of bonuses, commissions and extravagant salary rewards that overincentivize very risky behavior. If you constantly hold pots of gold just beyond reach over the edge of a cliff, a lot of people are going to leap off the cliff in order to grab it. Why shouldn’t making and protecting money for other people be seen as a modest business like any other? Why should the people who work in such a business get such a large piece of the action?
What is it that induces most of us to make good, sound decisions in our jobs? Well, we might get a raise; and we might get a promotion. We might just avoid being fired. And we might also seek the rewards of a job well done and doing right by the people who depend on us. But if I recommend that my company buys a new line of widget machines, and it turns out to be a good business decision, I don’t typically get a lifetime supply of widgets that I can then trade in for jets, yachts, black truffles and luxury-end suits of clothes. If I did, I might be overly bold in my recommendations of big expenditures. Maybe we should try to create an economy in which making $10 million dollars for someone just entitles you to a raise and a pat of the back, but not millions of dollars.
November 19th, 2008 at 1:01 pm
I wonder what percentage of Americans would agree to spend a few years in jail in exchange for a chance to live the CEO lifestyle for an equal number of years?
50%, maybe?
November 19th, 2008 at 1:02 pm
Maybe we should try to create an economy in which making $10 million dollars for someone just entitles you to a raise and a pat of the back, but not millions of dollars.
B-b-but then people working in the finance industry won’t be sufficiently motivated and—and—and—America will just fall apart! Also, rivers will run with blood, the sun will be dark at noon, and there will be a plague of locusts o’er the land!
November 19th, 2008 at 1:10 pm
Rather than taking someone out back and shooting them you put 100% of all C-level employee assets on the line. Use the Medicare/Medicaid rules: all assets down to $2000, including the sale of the primary residence. Sale of the primary residence cannot be forced, but as ownership transfers assets go to the company’s debt first, then the next of kin. Look back up to 10 years and all assets transferred to or gifts given to family are also included.
Treat C-level employees of companies that require a government bailout the way we treat “regular folks” who need to go on government assistance for medical coverage. Take everything.
November 19th, 2008 at 1:16 pm
To paraphrase Voltaire, “dans ce pays-ci, il est bon de tuer de temps en temps un financier pour encourager les autres.”
November 19th, 2008 at 1:21 pm
Interesting comment, Jack.
November 19th, 2008 at 1:29 pm
Looks like UBS has been trying to tackle this with their new and improved (from the shareholder side) bonus plan.
http://curiouscapitalist.blogs.time.com/2008/11/17/the-race-to-the-bottom-of-the-bonus-pool/
November 19th, 2008 at 2:09 pm
This bad idea ranks up there with Matt’s proposed eliminations of occupational licensing and Doris Kearns Goodwin.
I had an econ professor once say that the fastest, best way of increasing highway safety would be to ban seatbelts and airbags and to install 3-inch daggars at the centers of all steering wheels. Har har.
I get the point, but you could make the same argument about auto insurance: ban it, and boy, the consequences would be so bad, nobody would take any chances.
Uh, no. Auto accidents are bad enough, even with auto insurance, to make auto insurance a very good idea. And they’re unsettling enough that even with airbags and antilock brakes, people nonetheless generally make the effort to avoid them.
November 19th, 2008 at 2:16 pm
“See that big hole in the middle there between 1941 or so and 1984 or so?”
Quite large bubble in conglomerates and tech companies in mid-late Sixties. Go read Brooks’ The Go-Go Years. Don’t over-romanticize the era. There were also recessions and what might be an oil/commodity bubble in the 1970s.
November 19th, 2008 at 2:17 pm
I feel like Larry Kudlow at the CAP “holiday” party here, but give me a break, hetherjw and others. It is not possible to make money without taking on and effectively managing risk. If you drive the cost of risk-taking ridiculously high then nobody will ever take any risks…or only crazy people will. You want to draw and quarter anybody who assumes some risk and fails? Fine, you go to North Korea and tell me what that looks like, ok, champ?
There are practical ways of better tying longterm corporate performance to compensation…primarily, by tying longterm corporate performance to compensation. Right now companies are measured quarterly on performance, and executives are generally compensated annually. That creates an incentive for executives to seek spectacular 12-month performance and to neglect longterm concerns and risks.
Oh, but threatening executives with decapitation is so much more exciting, such a frisson revolutionary fervor.
November 19th, 2008 at 2:18 pm
Problem is some of these corporations get so big, they get to hold the taxpayer hostage, b/c if they fail they do a lot of collateral damage.
If they get big enough that they are “too big” they should be heavily regulated.
I’d be fine with booms and busts if there was a decent safety net and there were decent union laws, but I don’t see either of those happening anytime soon.
November 19th, 2008 at 2:21 pm
Peter K – exactly. James Brock (another prof of mine – not the one with the steering wheel daggars) wrote a book about this, The Bigness Complex. One part of the solution must be an effort to prevent companies from becoming “too big to fail.”
November 19th, 2008 at 2:28 pm
If you drive the cost of risk-taking ridiculously high then nobody will ever take any risks…or only crazy people will.
And if you leave the cost of risk-taking ridiculously low, then everybody will take unacceptable risks, which is what causes financial crises like the one we’re in now. What’s your point? (Also, what does North Korea have to do with this?)
November 19th, 2008 at 2:29 pm
Strip the top-level officers of their citizenship and banish them.
November 19th, 2008 at 2:44 pm
I don’t see why the free market won’t settle on the correct risk-reward relationship by itself if the government gets out. If the moral hazard inherent in public corporations gives them a disadvantage against private corporations, private corporations where all risk and reward is borne by the decision-makers should win out, no? Can someone explain why this isn’t the case?
November 19th, 2008 at 2:59 pm
“And that means taking a lot of risks with that capital, because the future often isn’t certain and it would be inefficient to fund only the projects with little or no risk.”
But the capital at risk is not the individual’s. Why should they get compensated as if it is?
This is not about managing risk. This is about recklessly seeking obscene wealth secure in the knowledge that, thanks to the goverment’s interest in preventing an economic collapse, you will be inoculated from the economic consequences of your mistakes.
November 19th, 2008 at 3:04 pm
She must be really fun at parties or something because I don’t see the attraction in talking with McArdle. She says something stupid and you correctly drill her over it. She has an over abundance of empathy for people who make millions while little if any for people who make 10’s of thousands.
November 19th, 2008 at 3:07 pm
“But you probably can’t prevent bubbles and manias and panics either. ”
You can lessen both their frequency and severity with proper regulation on leverage.
November 19th, 2008 at 3:08 pm
No, but expanding the scope of veil-piercing and enacting mandatory clawback-upon-insolvency provisions for corporate officers and executives would be a nice first step toward reducing the potential damage done by corporations (to their shareholders, as well as to other people doing business with the corporation). Like dynamite or automobiles, corporations are both useful and dangerous and should not be used recklessly.
The difference is that nobody would take seriously a politician who proposed deregulating dynamite or eliminating DUI laws.
Or broken up like AT&T, or prevented from getting that big in the first place via regulatory veto of mergers.
The dominant cause of this problem is that the people responsible for preventing it were grossly corrupt and turned their backs. The tools to regulate it were already in place but the Bush Administration didn’t use them (and/or actively vandalized them). You might as well throw open the doors to the National Dynamite Depository and walk away – sure, everyone who steals a stick and blows something up is partly responsible, but the lion’s share has to go to the fool who made all the other folly possible.
November 19th, 2008 at 3:43 pm
Linkmeister Says:
November 19th, 2008 at 12:33 pm
Japanese executives whose companies/institutions fail occasionally commit seppuku. That’s probably an extreme sense of morality no Wall Street executive would ever exhibit……
There was a time when Wall Streeters did commit suicide over failure. The stereotype was leaping from a skyscraper but using a handgun was also quite popular…..
November 19th, 2008 at 4:18 pm
DTM,
I think one plausible explanation is just that there is really no way for the number of individuals involved to internalize all the risks they can sometimes be creating.
This is inarguably true. However, it would seem that on a question like private vs public company, there will always be more moral hazard risk in a public company, and there’s a very easy way to get rid of that risk–keep the company private. Similarly, limited liability will always present more moral hazard than unlimited liability, and in a free market that’s a choice the company gets to make. So for limited liability and public companies to survive on the market, they must have some competitive advantage which at least equals the moral hazard cost.
So it’s not just that there’s a certain minimum beyond which personal responsibility for risk cannot go further, since the market seems to settle on a risk/reward relation more disconnected than the minimum possible.
November 19th, 2008 at 4:31 pm
Since no single regulatory scheme is going to work perfectly, I wish the government would be more aggressive about locating bubbles in advance of them becoming problematic.
I suggest not restricing executive compensation, but carefully monitoring it as a bellwether. It seems like no matter where a bubble emerges in the economy, it almost always results in one or another of the large financial institutions hugely overcompensating its exectuives.
If the feds were watching executive compensation for anomalous or rapid growth, and if rapid changes in executive compensation automatically led to a higher level of scrutiny from regulatory agencies, then it would probably a) help regulatory agencies anticipate product lines where risk management would begin to fail industry-wide, and b) provide some negative feedback to the emergence of high-risk financial products.
November 19th, 2008 at 5:49 pm
“Can someone explain why this isn’t the case?”
I can’t tell you specifically, but I can make a general guess: there are other, compensating advantages that a corporation enjoys which offset the private company advantage you mention. Specifically, easier access to capital, possible. Also, while top management at private companies, having more personally at stake, are presumably more rational about risk analysis, the public nature of corporations may, in the end, act more as a brake against excessive risk-taking.
The sort of “just so” story you’re looking for is simplistic. The comparative quality of risk analysis at public versus private firms is certainly the result of a large number of interacting factors that cannot be easily disentagled, especially in the context of a thought experiment intended to prove or disprove an argument.
November 19th, 2008 at 7:58 pm
For protection against future financial emergencies, without strangling innovation with overregulation, what about offering bailout insurance to corporations?
For a negotiated premium, added to the company’s standard federal taxes, the government would guarantee some sort of bailout, to be determined on a case-by-case basis, in the event of the company’s failure. Details as to eligibility, deductibles, exclusions, claims and payouts, etc. can all be worked out.
If it turns out, as is likely, the U.S. shouldn’t get into the insurance game, maybe the whole market can be privatized. I hear AIG is looking for something to do.
Of course, this would have to be in addition to some minimum level of regulation. But it would allow corporate America to determine for itself how risky/incompetent/criminal they want to be, and how much they’re willing to hedge against disaster. At the same time, it provides government much-needed revenue without raising obligatory taxes. Bottom line: no insurance, no bailout … ever.
Just an idea.
November 19th, 2008 at 9:01 pm
It’s just not that complicated. The critical regulations are not at the individual transaction or financial instrument level, they are at the bank level.
All transactions to be on the books.
Lower leverage limits.
Greater anti-trust inspections to cut down on “banks too big to fail.”
The purpose? Not to prevent individual meltdowns, but to reduce the likelihood of contagion. Simple first steps.
Oh… and we don’t have to hang or shoot anyone… just stop listening to the glibertarians… that would make all the difference in the world for next time.
November 20th, 2008 at 12:24 am
awe, shucks, Megan writes so cute and is even a tall cutie from what I hear….but her airy dismissive disregard for real people is on a level of arrogance that even the worldclass climber Reinhold Messner couldn’t climb to her levels of cluelessness.
With rampant deflation, the billionaires even with 90 percent stock losses will be happy as pigs at the trough with landscapers and painters working for next to nothing on the fat cat’s numerous summer homes. The “help” will be cheap I’ll tell you.
November 20th, 2008 at 2:38 pm
Kevin@50: Wouldn’t work. The irrationally exuberant companies wouldn’t buy the insurance because they know their model is sound and they couldn’t possibly fail. Then they fail anyway and blow up the economy.
If they were capable of assessing that risk to the point of rationally deciding to buy insurance, then they’d be capable of limiting their leverage exposure, hedging, and otherwise managing their risk. One more risk-management tool would just be ignored by people convinced they don’t need to manage their risk.
The failure of any particular institution to buy bailout insurance doesn’t change the negative public consequences of allowing the institution to go splat, either. If it’s in the public interest to bail them out, the fact that it creates a moral hazard usually isn’t enough to outweigh that.
The solution to this is to make the insurance mandatory, but at that point you might as well just call it taxes and Keynesianism, because that’s what it is. Then Reagan repeals the taxes and you have to pay out without collecting the revenue first.
I wonder if it would be possible to pass a constitutional amendment banning tax cuts when there is a deficit but no recession. (I.e. any non-Keynsian tax cut must come *after* balancing the budget.) Irresponsible tax cut mania is one of the things that leaves the government poorly equipped to deal with the current problem (as well as overheating the bubbles themselves).
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