Moral Hazard - In economic theory, a moral hazard
is a situation in which a party is more likely to take risks because the
costs that could result will not be borne by the party taking the risk. In
other words, it is a tendency to be more willing to take a risk, knowing that
the potential costs or burdens of taking such risk will be borne, in whole or
in part, by others. A moral hazard may occur where the actions of one party
may change to the detriment of another after a financial transaction has
taken place.
Wikipedia says that Economist Paul Krugman described moral hazard as
"any situation in which one person makes the decision about how much
risk to take, while someone else bears the cost if things go badly."
Moral hazard is not only the misallocation of risk, but the mispricing
of risk without significant consequences as well. This also speaks to
the misallocation of risk. As in a bubble.
In our most recent financial crisis we saw both the mispricing of risk in the
initial collateralized debt obligations that fed the housing price bubble,
and in the aftermath, where much of the consequences of the ensuing financial
crisis were allocated to the taxpayers after the fact and without
an explicit prior agreement to do so, under duress.
A rather sophistic defense of that approach and subsequent policy was
provided by Larry Summers who in September of 2007 wrote an article entitled Beware
of Moral Hazard Fundamentalists:
"In the financial arena the spectre of moral hazard
is invoked to oppose policies that reduce the losses of financial
institutions that have made bad decisions. In particular, it is used to
caution against creating an expectation that there will be future
'bail-outs'."
As an aside, when I saw the
new 'reform President' bringing in Timothy Geithner, Hank
Paulsen, and Larry Summers to key posts in his administration, I
suspected that the people's mandate for reform had been deflected,
although there was the prior example of FDR bringing in Joe
Kennedy to spearhead the SEC. But, alas, Obama quickly
turned out to be no Franklin Roosevelt, but a loyal member of
the Wall Street wing of the Democratic Party.
And here we are, SEVEN years later. Forget 'future bailouts.' We
have what seems to be never-ending bailouts, and subsidies,
and special arrangements, and deals benefiting Wall Street, to the
detriment of almost everyone else.
Here is a video of Senator Elizabeth Warren from yesterday's testimony in a
hearing chaired by Senator Tim Johnson (D-SD) “Wall Street
Reform: Assessing and Enhancing the Financial Regulatory System.”
She begins by questioning Fed Governor Daniel Tarullo. As you may
recall, the Fed is one of the primary banking regulators, acquiring even more
and broader regulatory powers in the aftermath of the 2008 financial crisis.
Her second question about the TBTF Banks and failure resolutions goes to FDIC
Chair Martin J. Greenberg.
Near the end is a long statement/question from Senator Richard Shelby of
Alabama.
I bring this to light, in order to respond to those who say that the banking
system has already been reformed. It has not.
It is only 11 minutes in length and is worth watching. You can see it in its
entirety here.
Special thanks go to Pam Martens for bringing these quotes to light in her
excellent article, Jamie
Dimon Gets $8.5 Million Raise for Illegal Conduct at JPM. I had not
yet found a proper transcript. Pam's articles are consistently timely and of
high content value.
“As Judge Rakoff of the Southern District of New York has
noted, the law on this is clear. No corporation can break the law unless
an individual within that corporation broke the law. (unlike some
recent delusions from the Supreme court about the inalienable rights of
soulless, disembodied Corporations which are constructs merely of
common law with no superior claim to a higher authority equal to an
individual's rights - Jesse)
Yet, despite the misconduct at these banks that generated tens of billions of
dollars in settlement payments by the companies, not a single senior
executive at these banks has been criminally prosecuted. Now, I know that
your agencies can’t bring prosecutions directly, but you’re supposed to refer
cases to the Justice Department when you think individuals should be
prosecuted. So, can you tell me how many senior executives at these three
banks you have referred to the Justice Department for prosecution?...
After the savings and loan crisis in the 1970s and 1980s, the government
brought over a thousand criminal prosecutions and got over 800 convictions.
The FBI opened nearly 5,500 criminal investigations because of referrals from
banking investigators and regulators.
The main reason we punish illegal behavior is for deterrence; to make sure
that the next banker who’s thinking about breaking the law remembers that a
guy down the hall was hauled out of here in handcuffs when he did that.
These civil settlements don’t provide deterrence. The shareholders for the
company pay the settlement; senior management doesn’t pay a dime. And, in
fact, if you’re like Jamie Dimon, the CEO of JPMorgan Chase, you might even
get an $8.5 million raise for negotiating such a great settlement when your
company breaks the law.
So, without criminal prosecution, the message to every Wall Street banker
is loud and clear: if you break the law you are not going to jail, but you
might end up with a much bigger paycheck.
No one should be above the law. If you steal a hundred bucks on Main
Street, you’re probably going to jail. If you steal a billion bucks on Wall
Street, you darn well better go to jail too.”
