Do government bailouts create a moral hazard? Financial Times columnist Tim Harford says not really, and he adds that we shouldn’t get too bent out of shape when the federal government spends our dollars to save corporate giants (and their CEOs) like AIG and Bear Sterns.
First off, Harford says our current definition of the term moral hazard is a little strained. Harford reminds us that term originates in the, you guessed it, insurance industry and refers to the prospect that insurance will lead people to take undue risks and/or submit fraudulent claims:
Moral hazard can sometimes take extreme forms. According to the Florida newspaper the St Petersburg Times, in the late 1950s and early 1960s, more than two-thirds of insurance claims for the loss of a limb originated in the Florida Panhandle. At the epicentre, “Nub City” – the tiny town of Vernon, Florida – almost 10 per cent of the adult population had lost a limb. One man was said to be insured by dozens of companies when he lost his foot; fortunately he had been carrying a tourniquet at the time of the accident. He pocketed a million dollars. Another man shot his foot off – “while aiming at a squirrel” – just 12 hours after buying insurance. Now that’s careless – and that’s moral hazard in spades.
Harford continues: “If AIG had shot off its own metaphorical foot to claim a government bailout, the argument against the bailout would be compelling. But it didn’t, and it isn’t.”
In other words, AIG didn’t intentionally plot a course of destruction with the knowledge that there would be a soft, government-funding landing. Yes, they showed poor judgment, but they were, at the very least, truly hoping everything would turn out in the end.
Understandably, there is a lot of anger directed toward Wall Street these days–the collective pulse of the nation is now in the triple digits thanks to reckless (and perhaps predatory, if you ignore Joe Six-Pack’s lies on his mortgage application) lending practices. But Harford admonishes us that we shouldn’t get overly vindictive toward Wall Street–for our own sake.
The government will not help you replace your possessions if you smoke in bed and your house burns down, but government-funded fire engines will put out the blaze, moral hazard or not. That is partly because fire can spread, and your neighbors should not suffer for your carelessness. The same motive lies behind the current spate of rescues. It is also because a civilized society tries to save people from accidentally burning themselves to death. If the consequence is a little more carelessness, so be it.
Yes, AIG was careless, but if we insist on letting it burn, we will end up fighting the same flames when they extend to Main Street. Read the entire article.
