Moral hazard

Compelling point about moral hazard, courtesy of Credit Slips:

While moral hazard concerns are a real issue for any government aid to borrowers or lenders, its worthwhile remembering a major exception to moral hazard--third-party costs. As Larry Summers summarizes: When the fire department rescues people who start fires by smoking in bed, it creates a moral hazard for in-bed smokers. But no one gets exercised about moral hazard, in part because we know that fires can spread and burn down neighbors' apartments in "contagion" fires and that the in-bed smokers won't take care to insure their neighbors. That's what we're seeing in foreclosure crisis--mounting third-party costs to neighbors and local government. If the municipal government goes bankrupt [for readers in California, think about Vallejo], it affects everyone in the community--indeed, those who had to relocate because of foreclosure escape this consequence. Foreclosure is a real problem for everyone, not just those who get kicked out of their homes or whose investment portfolios take a hit.
The point they're making is aimed mostly at people that think those who purchased homes they couldn't afford should just live with the consequences of their stupidity. However, it could be extended to those that think that the Fed did the wrong thing in "bailing out" Bear Stearns. The people that got bailed out at Bear Stearns weren't the employees or the shareholders. In fact, pretty much all of those guys got screwed. The people that got bailed out were Bear's counterparties, who didn't have much to do with Bear's business beyond funding it.

blog comments powered by Disqus


Copyright 2006| Blogger Templates by GeckoandFly modified and converted to Blogger Beta by Blogcrowds.
No part of the content or the blog may be reproduced without prior written permission.