moral hazzard, bailouts and debtors prison

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moral hazzard, bailouts and debtors prison

Postby kiryan » Wed Dec 17, 2008 7:07 pm

One of the prime arguments against bailouts is that it creates moral hazzard. Corth wrote on this extensively in other threads. You take outsized risks to earn outsized, private gains, and if you fail the government makes you whole, transfers the losses to the public (tax payers). There is little personal consequence for risk taking so risk is abnormally cheap to the individual and works against free market forces.

I was thinking, they used to have a debtors prison... if you didn't pay your bills they hauled your ass off to jail. Stopping this practice seems like moral hazzard as well. I think about how all of this is in some sense due to irresponsible borrowing (vs irresponsible lending). WE took on more debt than we could afford... WE don't have the liquid savings necessary to bridge the average 6 months it takes to get a new job... WE are the foundation of this problem, because we can't pay back what we borrowed. Should we reinstate debtors prison? Did we already do that to some degree by revising bankruptcy laws 4 years ago to make it harder to erase your debt... you don't go to jail, but having to repay that debt is a prison sentence for some... virtually slavery.

Another thought is that a few people have been calling for some of these executive managers to be thrown in jail. Every time I hear it, I scratch my head and wonder what for? A colossal mistake? Negligence? Participation in a willing suspension of disbelief of the risks a business is taking and not disclosing/advising folks of the risks thoroughly? If you could figure out some way to put these guys in jail, this too would decrease moral hazzard... Would that be good?
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Re: moral hazzard, bailouts and debtors prison

Postby avak » Wed Dec 17, 2008 7:23 pm

Hazzard is a fictional county in Georgia.
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Re: moral hazzard, bailouts and debtors prison

Postby Corth » Mon Dec 29, 2008 1:41 am

Tyler Cowen (NY Times) wrote:Because Long-Term Capital owed large sums to banks and other financial institutions, the Federal Reserve Bank of New York organized a consortium of companies to buy it out and cover the debts. Alan Greenspan, then the Fed chairman, eased monetary policy to restart capital markets, which were starting to freeze up. Long-Term Capital’s shareholders were wiped out, but none of the creditors took losses.

At the time, it may have seemed that regulators did the right thing. The bailout did not require upfront money from the government, and the world avoided an even bigger financial crisis. Today, however, that ad hoc intervention by the government no longer looks so wise. With the Long-Term Capital bailout as a precedent, creditors came to believe that their loans to unsound financial institutions would be made good by the Fed — as long as the collapse of those institutions would threaten the global credit system. Bolstered by this sense of security, bad loans mushroomed.


Link

When we were discussing the bailout, Avak deemed my arguments concerning Moral Hazard as being essentially academic and not being sufficient to outweigh the concern for the real pain that would be suffered by main street in the absence of a bailout. I believe in his own way Lathander echoed that sentiment. The article I linked to above makes a pretty good case that the 1998 bailout of Long Term Capital Management supported the subsequent risk taking of the large financial institutions, who suddenly realized that they were too big to fail, thus eventually causing the current crisis.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth

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Re: moral hazzard, bailouts and debtors prison

Postby kiryan » Mon Dec 29, 2008 3:50 am

good article, but you need a WSJ account to read it.

Automakers are also too big to fail, precedent set back with Iacoca in what the 70s?

Airlines were I believe too important to fail.

Homeowners also seem to be too important to fail if you listen to what the Dems are trying to push through congress...
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Re: moral hazzard, bailouts and debtors prison

Postby Corth » Mon Dec 29, 2008 4:05 am

Its New York Times. You can get a password on bugmenot.com

If I knew I couldn't die I'd be jumping out of planes, climbing mt. everest, having unprotected sex with bitches and hos. who the hell knows what else. When you tell a financial institution it can't die, it levers up and makes risky financial bets. The clear signal sent to financial institutions in 1998 and even before then was that you can't die. To me, its clear that moral hazard is culpable to some extent for the current crisis.. and the seeds of the next crisis reside in the current baiout.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: moral hazzard, bailouts and debtors prison

Postby avak » Mon Dec 29, 2008 9:43 pm

Corth, I certainly don't intend to categorize your arguments as academic; I think you are making very rational points. I don't know what to make of the Times article. On one hand, I see your point, but on the other, the gov't forced the shareholders to take the losses. That's what I would like to see more of in this current 'bailout' scenario.

I think we can have a managed bailout that prevents the moral hazard you are referring to. My main point would be that I believe an intelligent regulatory body could isolate the losses to the companies that made bad decisions. I don't believe that we all have to suffer as a result.
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Re: moral hazzard, bailouts and debtors prison

Postby Corth » Mon Dec 29, 2008 10:13 pm

Note though that although the government forced shareholders to take losses (something I agree with), creditors were made whole. Thats the key point. Think about where we are right now. Reckless lending.. i.e. imprudent creditors.

You and a lot of others have made the point that the current crisis resulted in large part from insufficient regulation and oversight. I tend to agree actually. I have been giving this a lot of thought lately. If you are going to have a system like this one where losses are socialized (bailouts), then it is incumbent upon the government to protect the taxpayer by stringently overseeing and regulating the financial institutions that the taxpayers are insuring. If you want to have a pure free market system then regulations and oversight should be minimal, but a clear message must be sent that there will simply be no bailouts, that the government is NOT there to help. You can't have an unregulated free market scheme with the message being sent that the government is always there to help. It encourages excessive risk taking because nobody is watching and the losses are socialized anyway.

Although I think its a bad idea, it seems like society has concluded that certain institutions are 'too big to fail', and thus their losses must be socialized. If we are going to go down that path, which seems inevitable, then the government is grossly negligent going forward if it fails to closely regulate these institutions.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: moral hazzard, bailouts and debtors prison

Postby kiryan » Wed Dec 31, 2008 1:21 am

good observation. if we are going to bailout, we must stringently regulate.

oh god ive crossed to the dark side.
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Re: moral hazzard, bailouts and debtors prison

Postby Kifle » Wed Dec 31, 2008 10:07 am

kiryan wrote:good observation. if we are going to bailout, we must stringently regulate.

oh god ive crossed to the dark side.


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Re: moral hazzard, bailouts and debtors prison

Postby Ashiwi » Wed Dec 31, 2008 4:57 pm

Are the coffee and pastries free?

Because the free market isn't any such monster.

They probably tell you the coffee and pastries are free, then add it into your tax burden.
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Re: moral hazzard, bailouts and debtors prison

Postby kiryan » Sat Jan 03, 2009 1:29 am

http://www.usnews.com/blogs/flowchart/2 ... -fail.html

specifically discussing how bailing out bear sterns may have lead to Lehman brothers counting on the government to bail them out. Lehman brothers didn't get bailed out and then went into a disorderly bankruptcy where recent reports are coming out and saying that billions of dollars in assets (companies which could've been sold in an orderly bankruptcy but instead just disappeared one morning) were destroyed because they did not plan a bankruptcy. They go on to talk about how Lehman brothers was run recklessly and that the CEO was paid 240 million between 2005 and 2007.

I also remember a differenet article quoting the CEO or chairman of lehman brothers saying literally, I'll never understand why lehman brothers wasn't bailed out but bear sterns and aig were. and that pretty much defines moral hazzard. Lehman brothers was expecting to be bailed out because Bear sterns was.
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Re: moral hazzard, bailouts and debtors prison

Postby Corth » Sat Jan 03, 2009 2:14 am

Well, if you think about it, the Lehman guys have a point. The government bails out Bear Stearns.. keeps the bankers employed, the bondholders whole.. but Lehman gets the middle finger. I'm not sure if its the right term, but "arbitrary and capricious" comes to mind.

Actually, at the time, the consensus was that the reason the government didn't bail out Lehman was that the powers that be were, ironically enough, worried about moral hazard ramifications. Then when Lehman failed, the stock market went to crap and there was concern about a genuine market meltdown.. so when AIG started having problems the government decided that they had to stop the dominoes from falling. George Bush abandoned his allged free market principles, and the rest is history.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: moral hazzard, bailouts and debtors prison

Postby kiryan » Sat Jan 03, 2009 2:27 am

I follow you, but I think the article gives some strong points for not bailing out lehman brothers. How recklessly the company was run. That they turned down an offer to sell/merge earlier. And what better way to send the message that you're bailout is not guaranteed by not bailing out the next guy who thought they were too big to fail. Especially if they are super egotistical about its inevitability. Also, bear sterns was the first and much smaller. They get some credit for being first in my mind... to prevent an immediate domino effect... gave the other players what 6 months to figure out a game plan. yet lehman bros plan A was bailout.

The article also makes the case that AIG was more responsible for the market crash than Lehman brothers because holy shit a mega insurance company went down. I can see that... no one knows 100% but if the crisis was not just banks, and it started taking down other triple A rated companies...
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Re: moral hazzard, bailouts and debtors prison

Postby Corth » Sat Jan 03, 2009 2:32 am

Well, you know me.. if I had my way I'd let them all sink and burn. But if they were going to bail anyone out, AIG would be the one. I think that bailout started at 80 billion, and now its up to around 150. And its probably just getting started. Makes the auto manufacturers look like small time panhandlers.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: moral hazzard, bailouts and debtors prison

Postby Lathander » Sat Jan 03, 2009 3:50 am

Lehman was a complete disaster by a government that is run by politicians instead of people that actually work for a living. That failure created the panic which led to runs on banks and the spread of the credit crunch. The current situation is one in which the answer is to continue to throw liquidity and equity at the problem because that is the only way to solve it. The CEO of Lehman was a moron, but his hubris didn't have to be a penalty for the broader economy.
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Re: moral hazzard, bailouts and debtors prison

Postby Corth » Sat Jan 03, 2009 4:16 am

Umm, I wouldn't say Lehman lead to runs on banks. I mean, by the time we got to Lehman we already had Countrywide, Indymac, Bear Stearns, Fannie/Freddie and probably a few others that I don't remember. Undoubtedly, it was a real shock to the markets, which had grown comfortable with the notion that nothing would ever be allowed to fail. My recollection is AIG became problematic right after Lehman failed. AIG failing would have been the equivalent of a financial nuclear bomb, which may or may not actually be exactly what the doctor ordered to start the process of clearing this tremendous amount of bad debt from the system.

Perhaps your right that bailouts were necessary. If so, its only because the imprudent acts of the financial industry had brought not only itself, but the entire country to the brink of disaster. If thats the case, then I blame the "Greenspan put" which made the industry feel comfortable with its risk taking insofar as the government would never allow it to fail and moreover, I blame the government for not regulating an industry that the taxpayers implicitly insured against failure.

It is also disgusting that financial industry employees were allowed to make enormous salaries when ultimately it was the taxpayers taking all the risk. Every single financial company that is forced to take a dime of public money should be nationalized, with all equity holders wiped out. After all, if the taxpayers are taking all the risk, its only fair that they get all the reward as well. Socialism is PREFERABLE to this farce of a free market.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: moral hazzard, bailouts and debtors prison

Postby Sarvis » Sat Jan 03, 2009 4:21 am

Corth wrote:Umm, I wouldn't say Lehman lead to runs on banks. I mean, by the time we got to Lehman we already had Countrywide, Indymac, Bear Stearns, Fannie/Freddie and probably a few others that I don't remember. Undoubtedly, it was a real shock to the markets, which had grown comfortable with the notion that nothing would ever be allowed to fail. My recollection is AIG became problematic right after Lehman failed. AIG failing would have been the equivalent of a financial nuclear bomb, which may or may not actually be exactly what the doctor ordered to start the process of clearing this tremendous amount of bad debt from the system.

Perhaps your right that bailouts were necessary. If so, its only because the imprudent acts of the financial industry had brought not only itself, but the entire country to the brink of disaster. If thats the case, then I blame the "Greenspan put" which made the industry feel comfortable with its risk taking insofar as the government would never allow it to fail and moreover, I blame the government for not regulating an industry that the taxpayers implicitly insured against failure.

It is also disgusting that financial industry employees were allowed to make enormous salaries when ultimately it was the taxpayers taking all the risk. Every single financial company that is forced to take a dime of public money should be nationalized, with all equity holders wiped out. After all, if the taxpayers are taking all the risk, its only fair that they get all the reward as well. Socialism is PREFERABLE to this farce of a free market.


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Re: moral hazzard, bailouts and debtors prison

Postby kiryan » Sat Jan 03, 2009 4:46 am

I'd prefer that they all went bankupt as well. I'm certainly not defending the bailout of AIG. I'm just saying it was an interesting article and dealt specifically with moral hazzard.
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Re: moral hazzard, bailouts and debtors prison

Postby Lathander » Sat Jan 03, 2009 5:21 am

I believe it was September 14 or 21 when the news came about Lehman not getting a bailout, the Fed's forcing Merrill to sell themselves to BoA and that AIG was in deep trouble. Dick at Lehman was not an "inside guy" whereas Goldman had a big risk in AIG. Had AIG been allowed to go under, shit would've really hit the fan because of all the CDS's. With Lehman, the government ended up spending far more money that it would have taken to push Lehman on to another bank just as they did with Bear. The Feds have always used the "find a buyer" thing to take care of things. I think in the case of Lehman, you had alot of terrible personalities.

Once Lehman went belly up, traders knew they could break the banks. We saw it with the vicious decline in Morgan, Citi and others. As a result of this, the government had to really start dumping big money on those banks once they got into the single digits. Why do you think that Citi was allowed to keep a penny a share dividend? It was to allow those with directives to own dividend paying stocks to continue owning it. This was just a repeat of the runs on Enron and Worldcom where the stock price dictated the bankruptcy. Once stocks get low enough the penguin credit rating agencies will start downgrading creating a vicious cycle and once they are in the single digits, the CDS market can really lean on the company.

See alot of folks don't understand credit. I read a quote a couple of years ago about it, "Credit is faith of man in man." No bank has the money they owe their depositors because they lend it out. If everyone tries to draw their money out, then the bank goes belly up. The answer is the government has to put equity into the operation.

In regard to blaming the financial industry, I'd first look at government. The government forced banks to make loans to people that couldn't pay it back in the name of fairness. We're getting the same thing now with GMAC making 0% loans to people with 620 credit scores. 30 to 40% of those shitty loans are going to never be paid back requiring more cash to go into GMAC in order for GM to keep making cars and keep the union people getting a paycheck. Hell, Dodd, the head of the banking committee, got a sweetheart deal on his mortgage from Countrywide.

Some banks didn't get into trouble. Look at those that didn't want the TARP money, but the government forced them to take it to not create a stigma against those that needed it. If someone forced me to take money, then I'd do what I thought was the best for my company such as buying good depressed assets as we are seeing the weak banks being taken over.

The Greenspan put has always been a concern, but the true problem was it wasn't used this time. Instead we had an inept Fed Chairman out of acadamia, a Treasury secretary used to being a CEO not a politician, a President that is running out the clock and a Congress filled with morons more worried about getting campaign donations and sweetheart deals. That was the true problem that the decision makers did not work the problem correctly.
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Re: moral hazzard, bailouts and debtors prison

Postby Lathander » Sat Jan 03, 2009 5:24 am

And don't get me started on the "Mark to Market" nonsense either!
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Re: moral hazzard, bailouts and debtors prison

Postby Corth » Sat Jan 03, 2009 5:54 am

Our basic disagreement here, Lat, is that you believe that this was simply a crisis of confidence. I think that is a misguided conclusion. From a fundamental perspective, real incomes were not high enough to support continued appreciation of already inflated assets. Without continued asset appreciation, borrowers were unable to roll over their debt. It was not a sustainable situation, and confidence in the system eroded AFTER the defaults started.

I also do not buy the CRA argument that the government forced all these bad loans. In the aggregate, thats a lot of horseshit. Companies like Novastar, New Century, Freemont, and Countrywide were making a FORTUNE originating loans to non-creditworthy purchasers, and wall street was making a killing packaging the resulting subprime paper into securities to sell to very willing investors. The government didn't need to force bad loans.. everyone was making a fortune doing it voluntarily.

The fact of the matter is that a deflationary debt crisis was inevitable, just as it was in 1929, and every single time previously in recorded history that we had credit growth at unsustainable levels. The most constructive thing that can be done at this point is to figure out WHY it happened so that we can prevent this from happening again. Really, the only thing I get from your post is that the government should have moved quicker to bail out these institutions, including Lehman. You do not adequately address why these institutions had to be bailed out in the first place.

I, personally, lay the blame primarily upon Alan Greenspan for signalling to the markets that government would never allow large institutions to fail, regardless of the execesive risk they take in the name of short term profits and bonuses. I also blame Congress, the SEC, the Federal Reserve, FDIC, and other governmental agencies for failing to properly regulate these institutions, given the fact that ultimately taxpayers were implicitly insuring them. Finally, I blame George W. Bush for abandoning his principles and allowing these bailouts to occur, which will likely not even work, but WILL serve to perpetuate the moral hazard that gave rise to the execessive risk taking in the first place. I don't blame the CEO's, because they were actually doing exactly what one would expect them to do under the circumstances. Given the upside down incentive structure established by the various governmental actors, it was actually prudent for the CEO's to take excessive risks.. as they stood to make huge personal gains if the risks worked out, and if they failed, the taxpayers pick up the tab.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: moral hazzard, bailouts and debtors prison

Postby Lathander » Sat Jan 03, 2009 6:18 am

Rolling debt is just another form of banking using the capital markets with commercial paper being a good example. Had confidence not been beaten down when Lehman went under, most companies could have continued rolling their paper. When people figured out that the government was going to make things worse, their natural reaction was to pull their money and not roll it.

The boom and bust cycle is nothing new. The last big occurrence was the late 80's. The government came in with a bailout. Things still got tough, but we came through it because people had confidence. The natural recession moves assets from weak hands to the strong hands. The trouble this time was that most market actors figured the government was going to let things get so out of hand that the strong hands were going to go under as well.

See, in the financial markets, it's all about your counter party. That's who takes the other side of your transactions. If actors lose faith in your ability to deliver on your promises for cash or securities, they refuse to trade with you. That's what happened to Bear, Lehman and almost Citi. When that happens, you're finished.

The government encouraged bad loans by allowing Freddie and Fannie to buy those loans. They did not do it in the traditional way they buy mortgages and securitize them. Instead, the agencies used their implied government backing for cheap financing to manage a portfolio of this crap. This portfolio continued to get bigger and bigger with government approval creating more liquidity for the subprime market. In addition, the government allowed greater leverage in the system overall. The government's actions enabled the upswing cycle that created huge profits. Finally, if a financial company did not juice up earnings by getting into the act, they were likely to be viewed as an acquisition candidate for another firm that would take their assets and leverage them up. If there is a profit to be made, and you don't make it, someone else will!

I completely disagree with the implied similarity with the Great Depression. The government back then created the Depression by raising taxes and restricting credit. This completely stalled a bad economy into an absolute wreck. Yes, their is some threat of deflation, but I seriously don't believe we'll see a Depression. That would change if taxes are raised although even Obama seems to be signaling a delay in raising taxes at least.

In terms of the "why", I don't know if you mean why they HAD to be bailed out or what created the situation. The why the HAD to is simple. If they aren't bailed out, the economy around the world grinds to a halt. No credit stops business transactions and nothing moves. You would have world wide unrest and disaster in terms of lives. In addition, it is cheaper to circle the wagons around those institutions that are necessary than to allow them to completely implode. Even now, it is cheaper to look at existing companies as their intrinsic value as a going concern as compared to building that same business from scratch. Also, "mark to market" has created this crisis where for most mortgages they originate are immediately worth less than they put into the mortgage. Why would a bank make a mortgage that was worth 20 to 30% less than the cash they had to make it?
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Re: moral hazzard, bailouts and debtors prison

Postby Alta » Tue Jan 06, 2009 5:05 am

Ashiwi wrote:Are the coffee and pastries free?

Because the free market isn't any such monster.

They probably tell you the coffee and pastries are free, then add it into your tax burden.



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But I think Kiryan would only go if Corth were there.
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Re: moral hazzard, bailouts and debtors prison

Postby Kifle » Wed Jan 07, 2009 7:31 pm

Alta wrote:
Ashiwi wrote:Are the coffee and pastries free?

Because the free market isn't any such monster.

They probably tell you the coffee and pastries are free, then add it into your tax burden.



Gosh I love you Kelly! Can we go on another cruise?

But I think Kiryan would only go if Corth were there.


They'd just jerk off to their personal pictures of Ronald Reagan the whole time.
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Re: moral hazzard, bailouts and debtors prison

Postby Sarvis » Wed Jan 07, 2009 7:33 pm

Kifle wrote:
Alta wrote:
Ashiwi wrote:Are the coffee and pastries free?

Because the free market isn't any such monster.

They probably tell you the coffee and pastries are free, then add it into your tax burden.



Gosh I love you Kelly! Can we go on another cruise?

But I think Kiryan would only go if Corth were there.


They'd just jerk off to their personal pictures of Ronald Reagan the whole time.


Or pictures of 8 year olds with tramp stamps...
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Re: moral hazzard, bailouts and debtors prison

Postby Corth » Wed Jan 07, 2009 7:35 pm

Mmmm, Ronnie. Can you say it again? "Trust but verify". *wiggle* Sexah!

Sarvis, man.. stop projecting!
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: moral hazzard, bailouts and debtors prison

Postby Corth » Thu Mar 12, 2009 6:01 am

March 11, 2009
Economic Scene
The Looting of America’s Coffers
By DAVID LEONHARDT

Sixteen years ago, two economists published a research paper with a delightfully simple title: “Looting.”

The economists were George Akerlof, who would later win a Nobel Prize, and Paul Romer, the renowned expert on economic growth. In the paper, they argued that several financial crises in the 1980s, like the Texas real estate bust, had been the result of private investors taking advantage of the government. The investors had borrowed huge amounts of money, made big profits when times were good and then left the government holding the bag for their eventual (and predictable) losses.

In a word, the investors looted. Someone trying to make an honest profit, Professors Akerlof and Romer said, would have operated in a completely different manner. The investors displayed a “total disregard for even the most basic principles of lending,” failing to verify standard information about their borrowers or, in some cases, even to ask for that information.

The investors “acted as if future losses were somebody else’s problem,” the economists wrote. “They were right.”

On Tuesday morning in Washington, Ben Bernanke, the Federal Reserve chairman, gave a speech that read like a sad coda to the “Looting” paper. Because the government is unwilling to let big, interconnected financial firms fail — and because people at those firms knew it — they engaged in what Mr. Bernanke called “excessive risk-taking.” To prevent such problems in the future, he called for tougher regulation.

Now, it would have been nice if the Fed had shown some of this regulatory zeal before the worst financial crisis since the Great Depression. But that day has passed. So people are rightly starting to think about building a new, less vulnerable financial system.

And “Looting” provides a really useful framework. The paper’s message is that the promise of government bailouts isn’t merely one aspect of the problem. It is the core problem.

Promised bailouts mean that anyone lending money to Wall Street — ranging from small-time savers like you and me to the Chinese government — doesn’t have to worry about losing that money. The United States Treasury (which, in the end, is also you and me) will cover the losses. In fact, it has to cover the losses, to prevent a cascade of worldwide losses and panic that would make today’s crisis look tame.

But the knowledge among lenders that their money will ultimately be returned, no matter what, clearly brings a terrible downside. It keeps the lenders from asking tough questions about how their money is being used. Looters — savings and loans and Texas developers in the 1980s; the American International Group, Citigroup, Fannie Mae and the rest in this decade — can then act as if their future losses are indeed somebody else’s problem.

Do you remember the mea culpa that Alan Greenspan, Mr. Bernanke’s predecessor, delivered on Capitol Hill last fall? He said that he was “in a state of shocked disbelief” that “the self-interest” of Wall Street bankers hadn’t prevented this mess.

He shouldn’t have been. The looting theory explains why his laissez-faire theory didn’t hold up. The bankers were acting in their self-interest, after all.



The term that’s used to describe this general problem, of course, is moral hazard. When people are protected from the consequences of risky behavior, they behave in a pretty risky fashion. Bankers can make long-shot investments, knowing that they will keep the profits if they succeed, while the taxpayers will cover the losses.

This form of moral hazard — when profits are privatized and losses are socialized — certainly played a role in creating the current mess. But when I spoke with Mr. Romer on Tuesday, he was careful to make a distinction between classic moral hazard and looting. It’s an important distinction.

With moral hazard, bankers are making real wagers. If those wagers pay off, the government has no role in the transaction. With looting, the government’s involvement is crucial to the whole enterprise.

Think about the so-called liars’ loans from recent years: like those Texas real estate loans from the 1980s, they never had a chance of paying off. Sure, they would deliver big profits for a while, so long as the bubble kept inflating. But when they inevitably imploded, the losses would overwhelm the gains. As Gretchen Morgenson has reported, Merrill Lynch’s losses from the last two years wiped out its profits from the previous decade.

What happened? Banks borrowed money from lenders around the world. The bankers then kept a big chunk of that money for themselves, calling it “management fees” or “performance bonuses.” Once the investments were exposed as hopeless, the lenders — ordinary savers, foreign countries, other banks, you name it — were repaid with government bailouts.

In effect, the bankers had siphoned off this bailout money in advance, years before the government had spent it.

I understand this chain of events sounds a bit like a conspiracy. And in some cases, it surely was. Some A.I.G. employees, to take one example, had to have understood what their credit derivative division in London was doing. But more innocent optimism probably played a role, too. The human mind has a tremendous ability to rationalize, and the possibility of making millions of dollars invites some hard-core rationalization.

Either way, the bottom line is the same: given an incentive to loot, Wall Street did so. “If you think of the financial system as a whole,” Mr. Romer said, “it actually has an incentive to trigger the rare occasions in which tens or hundreds of billions of dollars come flowing out of the Treasury.”

Unfortunately, we can’t very well stop the flow of that money now. The bankers have already walked away with their profits (though many more of them deserve a subpoena to a Congressional hearing room). Allowing A.I.G. to collapse, out of spite, could cause a financial shock bigger than the one that followed the collapse of Lehman Brothers. Modern economies can’t function without credit, which means the financial system needs to be bailed out.

But the future also requires the kind of overhaul that Mr. Bernanke has begun to sketch out. Firms will have to be monitored much more seriously than they were during the Greenspan era. They can’t be allowed to shop around for the regulatory agency that least understands what they’re doing. The biggest Wall Street paydays should be held in escrow until it’s clear they weren’t based on fictional profits.

Above all, as Mr. Romer says, the federal government needs the power and the will to take over a firm as soon as its potential losses exceed its assets. Anything short of that is an invitation to loot.

Mr. Bernanke actually took a step in this direction on Tuesday. He said the government “needs improved tools to allow the orderly resolution of a systemically important nonbank financial firm.” In layman’s terms, he was asking for a clearer legal path to nationalization.

At a time like this, when trust in financial markets is so scant, it may be hard to imagine that looting will ever be a problem again. But it will be. If we don’t get rid of the incentive to loot, the only question is what form the next round of looting will take.

Mr. Akerlof and Mr. Romer finished writing their paper in the early 1990s, when the economy was still suffering a hangover from the excesses of the 1980s. But Mr. Akerlof told Mr. Romer — a skeptical Mr. Romer, as he acknowledged with a laugh on Tuesday — that the next candidate for looting already seemed to be taking shape.

It was an obscure little market called credit derivatives.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: moral hazzard, bailouts and debtors prison

Postby kiryan » Tue Mar 24, 2009 5:22 pm

great article.

imagine how people's perceptions would change if bernake went out and testified to this effect using the word looting.

The explanation is a bit too simplistic though, its not just a banker makign a bet and expecting the government to make it whole... its a herd mentality... a feedback loop. They started out making bets and got paid big, so they made bigger bets and others who thought they were too risk took bets out and each cycle the bets and the # of players got bigger.

The whole notion that its ok to do it because everyone else is doing it is flat out dangerous... do you remember when that wasn't a valid excuse? when people prided themselves on their good decision making in face of adversity and criticism because they held true to their ethics and morals? Americans don't take responsibility like they used to be, the 40 and younger crowd is a a nation of adult children as far as I can tell.

I love the part where he says they looted the money before the government even spent it. Its the 80s all over again.
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Re: moral hazzard, bailouts and debtors prison

Postby Botef » Tue Mar 24, 2009 6:22 pm

WASHINGTON (Reuters) - Nobel-prize winning economist Paul Krugman said in remarks published on Monday that the latest U.S. Treasury bailout program is nearly certain to fail, triggering a sense of personal despair.

U.S. Treasury Secretary Timothy Geithner on Monday unveiled a plan aimed at persuading private investors to help rid banks up to $1 trillion in toxic assets that that are seen as a roadblock to economic recovery.

"This is more than disappointing," Krugman wrote in The New York Times. ""In fact it fills me with a sense of despair."

"The Geithner scheme would offer a one-way bet: if asset values go up, the investors profit, but if they go down, the investors can walk away from their debt," the Princeton University economist said, citing weekend reports outlining the plan.

"This isn't really about letting markets work. It's just an indirect, disguised way to subsidize purchases of bad assets," he added.

Krugman called it a recycled idea of former Treasury Secretary Henry Paulson, who later abandoned the "cash for trash" proposal.

"But the real problem with this plan is that it won't work," he says, adding that bad loans may be undervalued because there is too much fear in the current climate.

"But the fact is that financial executives literally bet their banks on the belief that there was no housing bubble, and the related belief that unprecedented levels of household debt were no problem. They lost that bet. And no amount of financial hocus-pocus -- for that is what the Geithner plan amounts to -- will change that fact," Krugman wrote.

While the real economy is being hurt by the meltdown of the financial system itself, Krugman says this is not the first or the last time this has happened. And there are lots of roadmaps to get us out.

"It goes like this: the government secures confidence in the system by guaranteeing many (though not necessarily all) bank debts. At the same time, it takes temporary control of truly insolvent banks, in order to clean up their books," Krugman said.

Time is running out on the Obama administration to take control of the banks - and the crisis.

"If this plan fails - as it almost surely will - it's unlikely that he'll be able to persuade Congress to come up with more funds to do what he should have done in the first place," he wrote.

The White House strongly disagreed with Krugman's assessment, defending the administration plans on the morning talk shows.

"I think Paul's just wrong on this one," Christina Romer, head of the White House Council of Economic Advisers, said on ABC's "Good Morning America" show just ahead of the plan's release.

"This is really tails both the government and the private sector win, heads both the government and the private sector lose. We both are going to have, as the saying goes, skin in the game."
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Re: moral hazzard, bailouts and debtors prison

Postby Corth » Tue Mar 24, 2009 10:06 pm

I don't agree with Krugman often.. he is an economist pretending to be a liberal political operative.. but in this case he is absolutely right. Geithner's plan will fail. If the government absolutely needs to do something it should be nationalizing the insolvent banks temporarily as Krugman suggests.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: moral hazzard, bailouts and debtors prison

Postby Lathander » Wed Mar 25, 2009 12:48 am

I can't imagine the private investors that would get talked into taking part in this. Sure, the government says to strings attached right now, but just wait a bit. You'd have to be nuts to put your money up for this.
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Re: moral hazzard, bailouts and debtors prison

Postby Lathander » Wed Mar 25, 2009 2:06 am

Looks like one of Obama's guys has pulled out of the TARP leader role.

http://www.foxbusiness.com/story/market ... -tarp-wsj/
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Re: moral hazzard, bailouts and debtors prison

Postby amena wolfsnarl » Thu Mar 26, 2009 7:24 pm

Lathander wrote:Looks like one of Obama's guys has pulled out of the TARP leader role.

http://www.foxbusiness.com/story/market ... -tarp-wsj/



I'm sorry i see the word FOX in there and i think to myself...Biased and full of shit. could you find a credible source pls
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Re: moral hazzard, bailouts and debtors prison

Postby Corth » Fri Mar 27, 2009 12:52 am

Biased and full of shit news agency wrote:SAN FRANCISCO -- Hedge fund manager Frank Brosens has withdrawn from consideration as the lead candidate to head the Treasury's Troubled Asset Relief Program, The Wall Streeet Journal reported late Tuesday on its Web site, citing people familiar with the matter. The program is currently headed by Neel Kashkari, who was appointed under former Treasury Secretary Henry Paulson, but it is unclear how long he will remain in the position. Treasury Secretary Timothy Geithner is considering other candidates, including Herb Allison, the current president and chief executive of Fannie Mae , according to the Journal.


You're an idiot.
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



Goddamned slippery mage.
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Re: moral hazzard, bailouts and debtors prison

Postby amena wolfsnarl » Fri Mar 27, 2009 2:00 am

Corth wrote:
Biased and full of shit news agency wrote:SAN FRANCISCO -- Hedge fund manager Frank Brosens has withdrawn from consideration as the lead candidate to head the Treasury's Troubled Asset Relief Program, The Wall Streeet Journal reported late Tuesday on its Web site, citing people familiar with the matter. The program is currently headed by Neel Kashkari, who was appointed under former Treasury Secretary Henry Paulson, but it is unclear how long he will remain in the position. Treasury Secretary Timothy Geithner is considering other candidates, including Herb Allison, the current president and chief executive of Fannie Mae , according to the Journal.


You're an idiot.


Sorry corth its not my fault you cant spot a joke.
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Re: moral hazzard, bailouts and debtors prison

Postby Corth » Fri Mar 27, 2009 2:09 am

uh-huh
Having said all that, the situation has been handled, so this thread is pretty much at an end. -Kossuth



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Re: moral hazzard, bailouts and debtors prison

Postby kiryan » Mon Feb 15, 2010 5:58 pm

http://www.huffingtonpost.com/david-pau ... 62572.html

Great article on Huffingtonpost about moral hazard as a result of the EU bailing out Greece. Bailouts are the problem is his conclusion.
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Re: moral hazzard, bailouts and debtors prison

Postby Corth » Mon Feb 15, 2010 6:00 pm

Government finances: The emperor wears no clothes.
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Re: moral hazzard, bailouts and debtors prison

Postby kiryan » Mon Feb 15, 2010 6:49 pm

http://money.cnn.com/2010/02/13/news/ec ... /index.htm

An article on the looming need for additional state bailouts, I mean support. Of course we have to remember the stimulus contained a lot of money that bailed out the education system and government employees which at the time Obama specifically said several times, DO NOT USE THIS MONEY TO COVER BUDGET DEFICITS BECAUSE IT WON'T BE HERE NEXT YEAR. Use it sustainably. Of course, no one had the political will to heed his advice, they used it to prevent layoffs and firings and now they are or will soon be looking for another bailout.

Obama +1.
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Re: moral hazzard, bailouts and debtors prison

Postby Corth » Mon Feb 15, 2010 7:04 pm

Amorphous 'aid' to the states doesn't mean very much. Wait until NY or CA begin defaulting on their debts. Then we are back into bailout territory, similar to the EU's position with Greece. So with respect to moral hazard: If you are a legislator from a fiscally conservative state, let's say Nebraska, and you see California spending like crazy on social programs that ultimately Nebraskans have to pay for when CA gets bailed out by the Federal Government - did you do a good job for your constituents? Apparently not, as they're money was redistributed to California which got to enjoy years or subsidies and social programs that were ultimately paid for by Nebraskans who were frugal and didn't spend as much on themselves.

Nebraskans could perhaps be forgiven for voting in a bunch of spendthrift legislators so that perhaps Iowan money can be redistributed to them once Nebraska obtains it's well deserved bailout.

What happens when all 50 states need a bailout?
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Re: moral hazzard, bailouts and debtors prison

Postby kiryan » Mon Feb 15, 2010 8:26 pm

Well... you have to appreciate that "aid" is really political speak for a bailout. Isn't that what we call it when a company is going to go bankrupt and we give them money to prevent that? We did it to some degree with the stimulus, but they squandered it and soon the real bailouts are going to begin and be demanded.

I don't think you could compare the calamity facing the EU with the one we are disbelieving in. Greece is one of the smallest economies of the EU, California one of the largest, most populous states who's economy if independently ranked had been as high as 5th in the world. Fortunately, it costs everyone too much to disbelieve in the dollar... for now.

But you're point stands when California is 32-36% of welfare cases and 12% of the population vs Texas at 8% of the population and 3-4% of welfare. Why would hard working Texans feel the need to support the socialist liberal welfare policies of California that have bankrupted it?

I heard something on Rush driving back from lunch... in NJ, $125k investment into your retirement over the course of your career as a unionized government worker nets you 3.8 million when you retire at 49 (including 500k in healthcare benefits). I don't know if thats true, but if its exaggerated, its still nothing like we face in the private sector. California has been talking about unfunded public employee retirements, Oregon had a huge fiasco about 10 years ago where they revamped their program (for new hires, everyone else was grandfathered). Oregon's system was so crazy that you could retire and get a pay raise. You could work for 29 years as a janitor making 30k, get a job making 80k in your 30th year and retire as if you made 80k the entire time. Does this not sound familiar... Isn't this EXACTLY what happened to GM and Chrysler (and Ford to a lesser degree)?

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