Moral Hasard

PBS has done an entertaining, but educational, segment on the The Newshour with Jim Lehrer about Moral Hasard.

This is well worth watching at the very least for the comedy bits which are taken from a Bird and Fortune comedy skit on the credit crunch:



Back to the PBS video: I object to the viewpoint of Catherine Mann of Brandeis. She argues against bailing out institutions because of "moral hazard". At 10:00 into the video she argues against the "rescue" of Bear Stearns because it "gives those institutions a green light to engage in riskier investments than they otherwise would have, to that extent they create an environment of moral hasard". Yes that is true. But two things:

1. If you want no risk, we can just shut down the institutions. Nobody risks anything. Business grinds to a halt. We are all safe but impoverished living in Hobbes state of "war of all against all" and living out our "solitary, poor, nasty, brutish, and short" lives.
2. If you accept risk, then you strive to moderate it, not elimiinate it. Actions that "save the system" while trying to punish those who took excessive risks is as good as you can get.

In short, my complaint against her is that she is a "fundamentalist". She sees no gray ground between hard "truths". But the real world is a world of gray, of compromise, of best efforts. To demand to live in a world of "hard truths" and "absolutes" is to undermine what life we can have in service to ideas that are unrealizable. If you look around, most of the problems of the world are caused by people who insist of "every jot and title of the law". Most of our great literature is written to point out the travesty of justice, morality, and law when extremists demand the world conform to their black and white blinkered view.

Steve Cecchetti made it very clear that the Fed's rescue did in fact punish risk taking. But it tempered its punishment with a eye to its higher goal of "ensuring the system". The rescue was to prevent the collapse of the system. Punishing moral miscreants is a desireable goal, but has to be subservient to the goal of ensuring that the system survives. And, as he pointed out, there was in fact punishment meted because hundreds of billions were lost by shareholders, managers were sacked, and employees lost jobs and pensions. This should be sufficient to deter future risk takers. Will it prevent all future risk taking? No! And it shouldn't. We need a system with some prudent risk taking. The Fed's action is meant only to limit "reckless" risk taking. But you cannot stop reckless risky behaviour without stopping all risk taking because there is no clear line between reckless and prudent. As with all things in life. In many cases it is clear what is reckless and it is clear what is prudent, but there is a large middle ground that becomes clear only in hindsight. This is what the fundamentalist don't recognize or acknowledge. Their rigid morality that will stop "all" reckless risk taking would in fact hobble the system by trying to prevent -- in advance -- something that isn't always clear until events unfold and we understand them better.

So... the video is a good one. It educates. It entertains. And it should make you want to reach in and join the argument. That's be best kind of informative video.