Robert Reich: Moral Hazard (The Fed's bailout of Wall Street)

[flpoljunkie]

Moral Hazard

The Bush administration rejected the idea that homeowners caught in the sub-prime loan mess deserved government bailout -- but it endorsed the Fed's bailout of Wall Street. Trouble is, it's the latter group that should have known better.

Robert B. Reich
March 26, 2008

Months ago, when the president 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 not afford." Days ago, when he endorsed the giant Fed bailout of Wall Street, the president signaled it was government's job to bail out big bankers who had made decisions to buy and sell risky securities they knew (or should have known) they could not afford.

It's true that people tend to be less cautious when they know they'll be bailed out. Economists call this "moral hazard." But even when they're being reasonably careful, people cannot always assess risks accurately. Many of the mostly poor home buyers who got into trouble did NOT in fact know they couldn't afford the mortgage payments they were signing on to. The banks and mortgage lenders that pulled out all the stops to persuade them to the contrary were in a far better position to know; after all, they had lots of experience at this game. So did 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, and the hedge fund managers who quietly tucked them into their portfolios.

The real moral hazard in this saga started last summer when Fed Chair Ben Bernanke first 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 financing of markets." Translated, this means that lenders, credit-rating agencies, financial intermediaries, and hedge funds would be bailed out, one way or another, because they're simply too big to fail. Since then, the Fed's Wall Street bailout has gotten bigger and bigger.

Note that behind every one of these institutions lie thousands of well-paid executives who would have lost big if the Fed didn't come to their rescue. A few, such as those at the late Bear Stearns, did lose big. But most executives on Wall Street have not. Even though they had more information and experience at risk-taking than the suckers who borrowed their money, and even though executives at the top of these institutions typically earn more in a day than the borrowers do in a year, moral hazard somehow doesn't apply to them.

When it comes to risky behavior in the market, America has a double standard. We're told that economic risk-taking as the key to entrepreneurial success. But when big entrepreneurs take big risks that fail it's amazing how often they get bailed out.

Indeed, the history of modern American business is littered with federal bailouts, loan guarantees, and no-questions-asked reorganizations. Some are well known, such as the Chrylser bailout of 1979, the savings and loan bailout of 1989, and the airline bailout of 2001. Most occur in the relative dark, such as the 1998 bailout of giant hedge fund Long-Term Capital Management (courtesy of former Fed chair Alan Greenspan), 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 Ben Bernanke's Fed.

Bush's "ownership society" has proven a cruel farce for poor people who tried to become homeowners, and his minuscule response to their plight just another example of how conservatives use moral hazard to push their social-Darwinist morality. The little guys get tough love. The big guys get forgiveness.

http://www.prospect.org/cs/articles?article=moral_hazard

[izzie]

1. Our welfare queens are now all run by CEO's

I wonder if they were frat brother's of our dear President. I hate this govt. being run for big business. Really hurts the middle class which made this country so great. We are back to 1880

[zazen]

2. spread the term: "corporate socialism"

[izzie]

3. Good name. They have got the front row in Congress

I was really interested in Obama's speech today and then the stupid TV got these silly girls to cut him off and starting telling me what he just said. I would have liked to hear Obama say it. I have a problem running these tapes off the internet so sort of have to hear them on TV. I guess these silly girls have to earn their money but it sure makes me mad. Congress has to get to this oversight business and get ahold of these running wild corp.