Monday, January 18, 2010

Infinite Moral Hazards

As our entire health care sector may toward possible nationalization, the Congress and Administration now searches for new ways to turn up populist anger in their favor. This week the Administration came out with new excise fees on banks who received TARP money. For the average everyday hard working person who was not bailed out like the banks, it's tempting to take this pound of flesh offered to us (the mob) as an afternoon delight. Their strategy is make the American people believe that the banks m.o. of greed will not stop and they must be punished for their misdeeds after we've made them wards of the state. Of course, no taxes on bonuses will be executed against Fannie Mae, Freddie Mac, GM, Chrysler, or AIG.

If the President wants to send a message and really strike fear into the hearts of the "too big to fail" crowd, then maybe he should actually make it policy that no institution IS ACTUALLY too big to fail. The absence of doing just that creates and perpetuates the proverbial moral hazard. A moral hazard occurs when a party insulated from risk may behave differently than it would behave if it were fully exposed to the risk. In layman's terms, someone gambling in a casino with "house money" will most likely engage in riskier behavior than if that person were risking their own money. This type of moral hazard has been all too common in finance and banking dating back to the early 1900s through the creation of the Federal Reserve, fractional reserve banking, and FDIC deposit insurance. The three things all continually factor into our society's moral hazard problem that has become a cancer throughout our economy. When a company knows that it has an implicit backing of the federal government no matter what risks it takes, you will always be rewarding failure and discourage success and prosperity.

If the President wanted to remove the moral hazard, how about removing the FDIC backing from all of the bailout firms?  Wouldn't that really insert fear backing into the banks and send them a message that they are on their own?  Our government needs to stop picking favorites and only rewarding people who are politically connected and fund their campaigns.  Otherwise, the same old games are going to continue and the usual suspects will work their special favor magic till their hearts content.  The tax on TARP'd banks will not generate more lending when the banks know they can borrow money from the Fed at 0% and buy Treasury Bills at 2-3% at virtually zero risk.  The apparatus that the Treasury and Federal Reserve execute have show the sure incompetence of government intervention and what NOT to do to generate prosperity.

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