Moral Hazard and Financial Stability

Tim Hartford who wrote The Undercover Economist wrote a great article over at slate magazine on “moral hazard.” First, let me put up this great closing statement he makes about the article because if you read nothing else of this article read this:

“Bailouts can save the innocent as well as the culpable, but even when they don’t, it is fantasy to expect governments to refrain from them. It is useless to pretend otherwise: Bailouts are inevitable, and sometimes they are even desirable. The moral hazard they provoke is also inevitable. The final lesson: Insurers get paid for the insurance they provide; it would be nice if the taxpayer were shown the same courtesy.”

He does a pretty good job of explaining exactly what moral hazard is. This is what he says:

“The term originated in insurance, recognizing the idea that people with insurance may be careless—for example, paying for secure off-street parking looks less attractive if your car is insured.”

So moral hazard is important in a point that he didn’t mention but hinted at. The FDIC is a huge moral hazard problem we face. When someone knows that they have 100,000 of your money to spend however they want. They will. I don’t care if it is a bank or a neighbour. We turn bankers into bureaucrats and it is going to end up in losses.

How can you bring financial stability and minimize the moral hazard problem? That is the question we face and that is the question no one is talking about. Regulations have been the answer and they do not work. Can the free-market minimize the moral hazard problem better than the government and central planners? I would argue yes.

The rest of that article is here.


Published in: on October 6, 2008 at 11:22 am  Leave a Comment  
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