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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