More on Moral Hazard

Last week I addressed a flaw I saw in the “moral hazard” argument for avoiding any action, no matter how justifiable, on the grounds that it might encourage future risk taking. My point, briefly, was that risk taking is actually something worth encouraging.

This week in The New Yorker James Surowiecki exposes the other half of the flaw in the moral hazard argument. In short, it doesn’t happen. :

Why might the effects of moral hazard be smaller than expected? To begin with, most bailouts aren’t like deposit insurance, which is certain and quick. Financial bailouts are uncertain and messy, and they typically occur only after institutions have already suffered extensive damage. Bear Stearns, for instance, was “saved” only after its shares had fallen almost ninety-five per cent from the previous year, and it seems unlikely that either its laid-off workers or its battered shareholders came out of the experience anxious to engage in more foolhardy behavior.

Again, there are plenty of reasons to be leery of a spending package calculated to be just small enough to avoid the word “trillion,” but moral hazard is an argument that would win few converts even if it weren’t fatally flawed.

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The War is Won

American style democracy has come to Iraq:

Officials said on Sunday 7.5 million or 51 percent of the more than 14 million registered voters [voted].

From Saddam Hussein to enthusiastic self-government to American style apathy in 6 short years. It took us almost 200.

Looks like it is time for the troops to come home.

Iraqi election turnout not as high as hoped

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Moral hazard and market failure

Much of the talk last year about how to address the developing financial crisis focused on the concept of “moral hazard”. The concern about moral hazard led folks with no particular aversion to government spending to delay taking action at the earliest stages until the situation had snowballed beyond Lehman Brothers. Now people are starting to use the phrase again. As long as we’re waxing philosophical – and let’s face it, moral hazard is a philosophical, not an efficiency argument – we ought to take a look at another philosophical concept in this context: market failure.

The entire moral hazard argument is based on a simple, but fundamentally flawed, premise:

Markets always value risk taking efficiently.

Now, I’m a big fan of markets. Given the option, I’d always take the market failures in favor of bureaucratic control and the more common bureaucratic failures. Still, an intelligent discussion of moral hazard and risk taking requires acknowledging that the only way that moral hazard can even come into play is if markets failed to properly value risk taking at some point. Either risk taking was overvalued two years ago or it’s undervalued today, perhaps both. I think that it’s actually more of the latter.

Risk taking behavior doesn’t just mean making subprime loans, loans which are not actually losing that much money and would still be making money if not for job losses and media doom and gloom encouraging “jingle mail”. It even includes more than packaging those loans into securities, some of which are losing money by the boatload.

Risk taking includes a whole range of behaviors like:

  • Investing in a startup company like McDonald’s (1965), Wal-Mart (October 1970), Microsoft (1986), Ford (1903) or Google (2004).
  • Sailing three little ships west to get to the East Indies.
  • Signing an agreement to trade stocks under a buttonwood tree in an untested nation on a new continent.
  • Putting a man on the moon.
  • Committing the entire industrial might, technological expertise and human capital of a nation to defeat totalitarianism on two fronts.

One of the reasons market capitalism is so productive is that it encourages risk taking behavior, while socialism and all its variants discourage it. If risk taking is undervalued today, and I think it’s pretty clear that it is, then the efficient response would be to ignore moral hazard arguments and take actions that incentivize risk taking. Those actions could be the simplest things like tax credits for investments by business and durable goods purchases for consumers or they could involve government more actively subsidizing risk as with Treasury buying up mortgage backed securities or the Fed discounting commercial paper. In any case, while the philosophical argument that the market should prevail has some appeal it’s worth remembering that the same government took an active role in forcing risk to be undervalued in the first place. The best place to deal with economic moral hazard is the same place we deal with every other moral hazard – the courtroom. Those who broke laws should be punished and those who played fast and loose with other people’s money and then came feeding at the public trough should be banned from the banking, securities or insurance industries. But public policy towards protecting shareholders, creditors and taxpayers and ultimately ensuring that markets do function efficiently shouldn’t be held hostage to false concerns that undervalue entrepreneurship.

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The Banker’s Depression

It’s funny that today Lawrence Kudlow wrote a blog post (Tough GOPers Stand Up to Geithner; All GOPers Should Counter Keynesian Stimulus ) on the need to oppose Keynesian stimulus just as more news came out showing that bankers are playing a game of chicken with the the pro-Keynesians. The new housing starts report today showed that builders are doing exactly what they should – cutting new production 50% year-to-year in the face of falling prices, an inventory glut and bankers refusing to roll over construction loans to solid builders. Consumers are doing exactly what’s been asked of them – new applications for home purchase mortgages rose again despite the continuing chorus of doomsayers.

Meanwhile, bankers are just sitting on a pile of new money – the Federal Reserve has printed and put in bank reserves $238 billion new dollars in the last 12 months. That’s a massive 15% increase in the monetary base (M1 for the technically minded). But bankers aren’t lending it. Ditech reports:

Fall out for refinance applications are estimated at 50% to 65%, because of low appraisals and qualifying issues. The new Fannie Mae and Freddie Mac appraisal code may contribute to more fall out, as well as FHA’s 2 appraisal requirement for cash out refinancing over 85%.

The neoclassical and supply side arguments against Keynesian stimulus hinge largely on the idea that saving isn’t actually removed from the economy as Keynes posited, but is actually invested – in stocks, bonds or bank accounts. And that money deposited in bank accounts isn’t a leakage, because banks will lend it. Except they aren’t.

Monetarists contend that Keynesian fiscal stimulus just isn’t as effective as monetary stimulus. They generally lean toward the conservative, free market view when it comes to what fiscal stimulus might be acceptable that, to paraphrase Milton Friedman, any tax cut is a good tax cut. But we’ve had some $600 billion of monetary stimulus between the Fed action and the TARP and it’s not being lent, putting the lie to monetarism as well.

To all outward appearances, money invested in bank accounts in this environment, whether by a newly positive personal savings rate or by a massive monetary stimulus, is a classical Keynesian leakage.

I agree with Kudlow that what we really need are supply side incentives to bring back real investment; unfortunately the actions of the big bankers are putting more ammunition behind the Keynesian argument and making sensible folks sound like the lunatic fringe as evidence mounts against us.

The small consolation is that the bankers will pay for this as much as anyone, as a slower economy with massively increased money supply means more of the loans they hold will go bad AND those paid back will be paid back with depreciated dollars. This economic event may deserve the title The Banker’s Depression – created by bankers, compounded by bankers and abetted by the bankers’ political cronyism even as the parts of the American economy that produce more than bookkeeping entries are more productive than ever.

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Rantlets: Gaza, Burris, Richardson

  • Message to Hamas: This day will the Lord deliver thee into mine hand; and I will smite thee, and take thine head from thee; and I will give the carcasses of the host of the Philistines this day unto the fowls of the air, and to the wild beasts of the earth; that all the Earth may know that there is a God in Israel.
  • If the party of Jefferson Davis won’t seat Roland Burris, the Party of Lincoln should stand up for the guy. He was legally appointed by the sitting Governor of his state. Last I heard, Blagojevich hadn’t even been indicted. Are all the actions of Dick Cheney and Alberto Gonzalez somehow called into question because they were? Are all President Bush’s appointments null and void because Dennis Kucinich filed impeachment articles against him? This is part and parcel of what a government of laws is all about – the law can function through an imperfect vessel. What is most important is protecting the system, not punishing one man.
  • It’s a shame to see Bill Richardson withdraw as Commerce Secretary designate. He’s not perfect – no one is. But he was the most qualified of any of the Democratic Presidential candidates and has a lifelong history of public service. “Pay-to-play” has become a convenient catchphrase politicians doing what politicians have always done – wheeling and dealing on behalf of their various voting and fund raising constituencies. It’s just the newest chapter in the politics of personal destruction, the era of politics by prosecution.


‘Twas the night before Christmas, when all through the house
Not a creature was stirring, not even a mouse;
The stockings were hung by the chimney with care,
In hopes that ST. NICHOLAS soon would be there;
The children were nestled all snug in their beds,
While visions of sugar-plums danced in their heads;
And mamma in her ‘kerchief, and I in my cap,
Had just settled down for a long winter’s nap,
When out on the lawn there arose such a clatter,
I sprang from the bed to see what was the matter.
Away to the window I flew like a flash,
Tore open the shutters and threw up the sash.
The moon on the breast of the new-fallen snow
Gave the lustre of mid-day to objects below,
When, what to my wondering eyes should appear,
But a miniature sleigh, and eight tiny reindeer,
With a little old driver, so lively and quick,
I knew in a moment it must be St. Nick.
More rapid than eagles his coursers they came,
And he whistled, and shouted, and called them by name;

“Now, DASHER! now, DANCER! now, PRANCER and VIXEN!
To the top of the porch! to the top of the wall!
Now dash away! dash away! dash away all!”

As dry leaves that before the wild hurricane fly,
When they meet with an obstacle, mount to the sky,
So up to the house-top the coursers they flew,
With the sleigh full of toys, and St. Nicholas too.
And then, in a twinkling, I heard on the roof
The prancing and pawing of each little hoof.
As I drew in my hand, and was turning around,
Down the chimney St. Nicholas came with a bound.
He was dressed all in fur, from his head to his foot,
And his clothes were all tarnished with ashes and soot;
A bundle of toys he had flung on his back,
And he looked like a peddler just opening his pack.
His eyes — how they twinkled! his dimples how merry!
His cheeks were like roses, his nose like a cherry!
His droll little mouth was drawn up like a bow,
And the beard of his chin was as white as the snow;
The stump of a pipe he held tight in his teeth,
And the smoke it encircled his head like a wreath;
He had a broad face and a little round belly,
That shook, when he laughed like a bowlful of jelly.
He was chubby and plump, a right jolly old elf,
And I laughed when I saw him, in spite of myself;
A wink of his eye and a twist of his head,
Soon gave me to know I had nothing to dread;
He spoke not a word, but went straight to his work,
And filled all the stockings; then turned with a jerk,
And laying his finger aside of his nose,
And giving a nod, up the chimney he rose;
He sprang to his sleigh, to his team gave a whistle,
And away they all flew like the down of a thistle.
But I heard him exclaim, ere he drove out of sight,



by Clement Clarke Moore

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Happy Festivus

Today is Festivus, the Holiday for the Rest of Us.

You can proceed with the Airing of Grievances in the comments if you like, or take it elsewhere if you’d rather.

Sorry, I have no Festivus pole (Grievance #1) so I’m using the pink aluminum Christmas Tree I stole from Charlie Brown (Grievance #2).

I didn’t get anybody any Festivus gifts (Grievance #3) because I thought that Festivus had been over commercialized (Grievance #4).

The Feats of Strength would commence after dinner but I don’t feel like wrestling (Grievance #5).

Happy Festivus.

(Feel free not to read this if you’re an easily offended “War on Christmas” type with no sense of humor.)

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The Christmas Map

I put together this map of Christmas related locations on Google Maps. (Input for additional locations is welcome – please comment!)

I specifically included these locations from past years Christmas posts:

Also included are:

  • The reputed inspiration for Bedford Falls, the town in the Kapra classic “It’s a Wonderful Life”
  • The New York City Macy’s location from “Miracle on 34th Street”
  • St. Paul’s Churchyard, mentioned in the opening paragraphs of A Christmas Carol
  • The hometown of Clark W. Griswold of National Lampoon’s Christmas Vacation.
  • The house from A Christmas Story.

And the little town of Bethlehem, now in the West Bank.

View Larger Map

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