Morality Play

Is moral hazard at the root of our financial troubles?

Many look at our recent financial crisis and say that the heart of the problem is moral hazard. That’s the problem you get when speculators get to keep the upside if things work out, but they offload any losses to the government.

Deposit insurance is a typical example. Small depositors have no incentive to check on their bank’s solvency, because the Feds will step in if there’s a problem. Supposedly, this incents bankers to go wild, because they get to keep the upside but the FDIC is stuck with any problems.

Only, not. For one thing, bankers who blow up a bank are out looking for a new job. And having a failed institution on your resume isn’t exactly a career builder. Also, having your bank taken over or forcibly merged isn’t exactly a walk in the park for depositors. Temporary hassles always appear, deposit rates can be re-written, and other stuff happens.

And there’s no evidence that things are worse now with deposit insurance. During the ‘20s and before we had financial crises, and supposedly there was no moral hazard because there was no FDIC. To me the moral hazard argument is too convenient: conservatives get to blame the government and liberals get to blame the banks.

It’s been said that when everyone thinks alike, somebody isn’t thinking. Let’s hope more clear thinking about moral hazard and the banks prevails.

Douglas R. Tengdin, CFA
Chief Investment Officer
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