Moral Hazard
Eric Dash writes for The New York Times:
But longer term, the new bailout could haunt regulators and taxpayers. The move ultimately may encourage banks to take more risks in the belief that the government will step in if they run into trouble.
Um . . . yeah. Look, I think these concerns about moral hazard can be overrated. Looking back on Lehman Brothers, plunging the entire world economy into a downward spiral just to teach a lesson to some uppity investment bankers doesn’t look so smart. But Paulson is proceeding as if this isn’t a concern at all. Or, rather, as if the health and welfare of wall street managers and shareholders is his primary responsibility. Sending such a giant pile of money over to Citigroup without removing the management, without clawing back the fortunes the management earned creating the mess, without adequately diluting the ownership stake of the bailed-out shareholders, and without taking any control on the board of directors is ridiculous. And, frankly, I didn’t see or hear the level of outrage from the incoming economic team that one would like to see.
28 Responses to “Moral Hazard”
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November 25th, 2008 at 8:30 am
There’s only one president at a time. I’m not sure what public outrage from the Obama team would have fixed; it would have only antagonized matters. Obama & co are in daily communication with Bush, Paulson & co. I’m sure they made their preferences and intentions known. But until it’s January 21st, there’s nothing O can do.
November 25th, 2008 at 8:30 am
The equity holders had already been wiped out by the market. Prior to the bail out the stock was sub $3. Which in the grand scheme of things was option value discounted for the possibility of a bankruptcy wiping out the option. The current $6 share price following the bail out is still an option value just with out the bankruptcy discount. Management change and clawback would be goodd ideas though.
November 25th, 2008 at 8:36 am
Heckuva job…Hankie?
November 25th, 2008 at 8:40 am
I’m with JPKK. Bailouts hardly helped the shareholders at all. And if I were them, I’d be clawing back some of the executive bonuses too.
November 25th, 2008 at 8:43 am
What, you actually thought this was about something other than Hank looting the treasury to help out his old Wall Street buddies?
And Obama’s team of Bob Rubin disciples has much the same set of priorities (most especially with respect to Citibank, of course.) No mystery there, either- alas.
November 25th, 2008 at 8:43 am
“it would have only antagonized matters.”
And that would have been a very, very good thing.
Look, there should be rioting in the streets over this outrage. But heck there should have been rioting in the street over Iraq, over torture, etc., etc. Americans are fat, stupid, evil sheep. Nowhere else in any “democracy” would the public stand still for this rape. We should be putting these people in jail. Instead we are showering them with money.
November 25th, 2008 at 8:46 am
Um . . . yeah. Look, I think these concerns about moral hazard can be overrated.
The time to worry about moral hazard was when we bailed out LTCM back in 1998. Once that occurred, the risk had already been incurred, and we are now paying for that in spades.
The current problem moral hazard is now a side issue to the actual hazard at hand: that being that the government has been captured by a bunch of crooks who are perfectly willing to destroy the real economy to save the fake economy and/or their reputations and/or their personal wealth and/or their egos. (There are also the follow-on hazards of the destruction of the currency and the good faith of the USG, the collapse of the real economy and so on and so forth.)
And, frankly, I didn’t see or hear the level of outrage from the incoming economic team that one would like to see.
Well, you know, Robert Rubin is rich and Larry Summers is a geenieus.
max
['Harvard: the elixir that cures everything.']
November 25th, 2008 at 8:59 am
Sending such a giant pile of money over to Citigroup without removing the management
Why? The current management wasn’t in place when Citi got itself into trouble. Look, way too much is made of the moral hazard argument (a point which MY acknowledges and then disregards). Citi’s stock is trading at 5-10% of its all time high. Do you really think that going forward, CEO’s are going to engage in the same high risk tolerant behavior just because they have the expectation of a bailout? I think the fear of losing 90-95% of your market cap is incentive enough to not engage in excessively risk ventures.
November 25th, 2008 at 9:09 am
Not related at all, but there’s been some pardon blogging, and this is funny in a our-country-is-being-run by a fucktard way.
November 25th, 2008 at 9:09 am
forgot the link:
http://wonkette.com/404589/george-w-bush-pardons-murderer-of-bald-eagle#more-404589
November 25th, 2008 at 9:11 am
What Lehman brothers showed was that everyone expected that the goverment would bailout big bank-like-thingies. Everyone turned out to be wrong and all bets were then off. Since everyone had assumed that lending to banks (or bank-like-thingies-of-a-certain-size) was safe, they would lend to such institutions without worrying too much about whether these organizations were just taking their money and putting them on black, hoping for a big win.
So the math is: equity in aggressive banks is risky, bond and stuff is perfectly safe, no matter how the bank (or similar) is run.
If markets had thought that there was even a remote chance that a Lehman-like bank would fail and hit lenders, the market reaction to Lehmans failure would not have been so huge. It was news that big banky things could fail and thus everyone panicked. Now the bailout is just trying to assure investors that, yes, Hank has got their back, and, yes, their moral hazard assumption are true. The whole world financial sector is based on this huge implicit goverment insurance and getting business back to normal just means goverment giving all the lenders their money back.
The assumption that somehow there is a healthy financial market that will be hurt by goverment bailouts in the long run since it will create expectations of a goverment guarentee is insane. There is a deeply sick, twisted and bloated financial sector, which needs to be downsized, neutered, regulated and turned into a very very very boring sector in the long run.
First step is wholesale nationalization of all major financial institutions of a certain size worldwide. Then we can start pricking up the pieces.
November 25th, 2008 at 9:17 am
Anyone else notice that they waited until Bush’s buddy, the Saudi prince, bought into Citi at a steep discount before announcing the bailout and causing the stock to double?
November 25th, 2008 at 10:03 am
This moral hazard obsession of Matt’s recently is of a piece with his soft spot for libertarians. Let’s face it: the free market model failed, and talking in terms of incentives isn’t going to bring it back.
A bailout may be a bad idea. It may not save an industry, as Obama expressed well with his line Monday about kicking a can down a street. It may encourage others to line up for more. It may put the stress on funding existing losers. It may remain corporate and “top down,” apart from needed stimuli whether one thinks in Keynesian terms or out of ethical beliefs that real people need help.
But it won’t do to talk about how to rig the game in this manner. A bailout, as others have said, won’t remove the risk to shareholders, as shares really did plunge, and if anything a bailout very much wants a business and its share price to recover, and there’s nothing wrong with that. It won’t alter the freedom from risk of the executives who have bailed out with their big bucks. For that matter, the trend in the last decade to link those big bucks to a stake in the company backfired big time.
You want those businesses not to go down the old paths that led to the subprime crisis or the reform-free auto industry, then you regulate them. You can do it outright, or you may do it as part of the terms of a bailout, but just do it.
November 25th, 2008 at 10:12 am
“….I didn’t see or hear the level of outrage from the incoming economic team that one would like to see…”
Of course you didn’t because Tim Geithner’s fingerprints are all over the Citi bailout. Wall Street loves Geithner because they know he’ll keep the BushCo/Bernanke/Paulson gravy train running on time.
Again, the biggest contributor to the Obama campaign was the financial services industry.
November 25th, 2008 at 10:15 am
There will probably be a significant change in regulatory scope and organization, partly in response to this moral hazard concern. Of course the next big financial crisis will be caused by something coming out of yet another left field (how many left fields can one financial universe have, anyway?).
November 25th, 2008 at 11:17 am
There’s another reason that the Citi bailout is crap; there’s nothing being put in place to prevent this from happening in another ten or twenty years. If they’re too big to be allowed to fail, then sure, bail them out, but then break them up into smaller bite sized chunks so that the next time they screw up they can be allowed to fail.
Too big to fail should mean too big to be allowed to exist in its current form.
November 25th, 2008 at 11:52 am
Michael Smith is exactly right. I’d just like to add that the market has already clawed back an enormous amount of executive compensation (tons of which was tied up in stock that had not yet vested and is now virtually worthless).
November 25th, 2008 at 12:14 pm
While I don’t think this totally undermines your broader point, the executives at citi who made the risky decisions have already been removed from their positions. This happened before the bailout was on the table.
It makes little sense to remove the current executives (who have only been on the job a short time) unless you can show their direct involvement in the problematic decisions.
November 25th, 2008 at 12:19 pm
I think Tomas above nails it. With what in retrospect looks like extreme dullness on my part, I’ve come to the conclusion that fundamentally the bailout is an extension of unlimited FDIC protection to bank creditors: depositors, bondholders et al.
The govt appears willing to let bank assets (mortgages, MBS etc.) go in the tank. Shareholders will take a bath. Management [not nearly enough of them] will take a [too small] hit. But bondholders and other creditors will be protected from losses.
This reminds me of the 1980s S&L crisis. Banks came along and offered jumbo CDs at ridiculously high interest rates. Some people jumped at the opportunity. The S&Ls were using this money to fund ridiculous real estate deals in the oil patch. When those deals went sour they couldn’t repay the CDs, much less the interest, but government stepped in since they were FDIC insured.
Paulson has taken this approach to what seems to be the entire liability side of banks’ balance sheets. Given typical bank leverage ratios, worrying about what happens to shareholders while ignoring this huge gift to creditors is keeping an eye on your pennies while someone is stealing your dimes and quarters.
I agree: if this is what too big to fail means, then it’s too big to exist.
November 25th, 2008 at 7:00 pm
why is matt continuously blogging about something he knows nothing about? this is the 2nd day in a row he’s in a tizzy about Citi’s s/h not being “wiped out”.
My boy, they’ve already lost 90% of what they had!
My lord, please stop MY before he makes a fool of himself.
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