Moral hazard datapoint of the day

By Felix Salmon
January 23, 2010
Jim Surowiecki,

" data-share-img="" data-share="twitter,facebook,linkedin,reddit,google" data-share-count="true">

In order to believe that there was a connection between moral hazard and the financial crisis, says Jim Surowiecki,

you also have to believe that the banks knew that what they were doing was reckless, and that there was a meaningful chance that it would wreck their companies, but decided that it was still worth doing because if everything went south, the government would step in. And that, even before Dimon’s comment yesterday, always seemed improbable.

But look what has happened in Sweden, when the government imposed a too-big-to-fail fee on its biggest banks, to help make up for the fact that it would have to bail them out in the event of a crisis.

According to Swedish officials, the stability fee has been welcomed by the banks that dominate the financial system. Smaller credit and financing companies complained bitterly, though, arguing that they would never be helped by the government in the event of a failure.

Maybe this is just the difference between Swedes and Americans — but I do think that there is a very real benefit to banks of having a government backstop. And they know it.

Comments
5 comments so far

“you also have to believe that the banks knew that what they were doing was reckless” – This statement simply shows the author has no idea what corporate executives are like and how they operate.

Sure business executives are generally smart, driven, ruthless people, nothing wrong with that. But more importantly, they don’t really know what they are doing most of the time. They simply follow conventional wisdom, no different from small-time (and big-time) speculators on the stock market; they do what other similar-sized companies in the same industry do; they focus on quarterly results. For the most part, they get to their senior position not by being more brilliant than their peers, but by being more acute politically, esp. true in large companies.

So, how is it that there’s no connection between moral hazard and rescuing (hence rewarding) the very same people who got their business to the brink of ruin? It’s irrelevant if they knew or not that their behavior earlier was reckless. Because, they SHOULD know, and if they didn’t, then they shouldn’t have been in a position to make those reckless decisions in the first place.

To be fair to the bankers, there’s a good chance they didn’t know they were taking too much risks. Like I said, I simply don’t believe they are that smart in the first place. But so what if they didn’t??? If I drove a car at 120-mile per hour, thinking I knew what I was doing and wasn’t taking a risk, and I hit someone, shouldn’t I be sent to jail? If I was let off because I “didn’t know” I was taking excessive risk, wouldn’t you call that moral hazard? Wouldn’t that encourage me and others to take the same risk? How and why shouldn’t the same principle apply to bankers and other business executives?

Why the Jim Surowieckis of the world are trying to make excuses for the Dimon, Blankfein, and the rest of the gang is exceedingly puzzling to me. Now, I know there’s a teeny chance the angry mob may take it too far over the bankers and punish them too harshly. But are we even remotely near that point to be worried?

Posted by jian1312 | Report as abusive

Probably Surowiecki was just spending too much time reading economics textbooks and forgot that there are no “banks,” but rather many individuals who work at a place called a bank. And these individuals are mostly trying to make a quick killing so they can retire by the time they are 40, and so just don’t have a very long time horizon.

Posted by johnhhaskell | Report as abusive

You don’t “also have to believe” that “the banks” (whoever that is) knew and believed these things; you may instead believe that the banks’ creditors believed such things. Bear and others (aside from Lehman) generally saw creditors entirely saved; employees often took a hit. The creditors would have been more right than employees. Lower financing costs would certainly have enabled this behavior, regardless of the other effects on the employees at the time they were taking their risks.

Posted by dWj | Report as abusive

“[In order to believe that moral hazard contributed to the crisis] you also have to believe that the banks knew that what they were doing was reckless…” This statement is false. One needs only believe that bank creditors expected Treasury’s backstop and that the corresponding subsidized borrowing rates contributed to more leverage.

Posted by Sandrew | Report as abusive

Oh, the banks knew they were being reckless. Unfortunately being reckless was the only way of squeezing out that extra return, and bankers who didn’t do that lost customers to the ones that did. As Citigroup’s Charles Prince said, “As long as the music is playing, you’ve got to get up and dance.”

Posted by KenInIL | Report as abusive
Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/