Moral Hazards

A colleague and friend wrote to me recently about what I thought of this article in last Sunday's The New York Times by Gretchen Morgenson, that starts off with a typical focus for The Grey Lady: the venality of big banks.

What are the consequences of a world in which regulators rescue even the financial institutions whose recklessness and greed helped create the titanic credit mess we are in? Will the consequences be an even weaker currency, rampant inflation, a continuation of the slow bleed that we have witnessed at banks and brokerage firms for the past year?

Or all of the above?

Stick around, because we’ll soon find out. And it’s not going to be pretty.

Morgenson's ire is focused mainly on the Fed-engineered "rescue" of Bear Stearns by JPMorgan Chase. She points to all the greed and grime that Bear Stearns has left in its rough-and-tumble wake as it gorged itself on the subprime feast. She labels it "this decade's version of Drexel Burnham" and advocates forcefully that, like Drexel, it should be "left to die."

She makes a telling point when she quotes William A. Fleckenstein, president of Fleckenstein Capital in Issaquah, Wash., and co-author with Fred Sheehan of “Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve.”

"Why not set an example of Bear Stearns, the guys who have this record of dog-eat-dog, we’re brass knuckles, we’re tough?" asked [Mr. Fleckenstein]. "This is the perfect time to set an example, but they are not interested in setting an example. We are Bailout Nation."

Morgenson agrees with Fleckenstein.

And so we are. After years of never allowing any of our financial institutions to fail, they have become so enormous that nobody will be allowed to sink beneath the waves. Otherwise, a tsunami would swamp the hedge funds, banks and other brokerage firms that remain afloat.

If Bear Stearns failed, for example, it would result in a wholesale dumping of mortgage securities and other assets onto a market that is frozen and where buyers are in hiding. This fire sale would force surviving institutions carrying the same types of securities on their books to mark down their positions, generating more margin calls and creating more failures.

Inevitably, she brings the "moral hazard" argument into the mix, through another quote, this one from Graham Fisher & Company analyst Joe Rosser.

"The Fed has now crossed the line in a very clear way on ‘moral hazard,’ because they have opened the door to the view that they are required to save almost any institution through non-recourse loans — except the government doesn’t have the money and it destroys the U.S.’s reputation as the broadest, deepest, most transparent and properly regulated capital market in the world."

Morgenson ruefully expects "the taxpayer," the poor, old, beaten-down taxpayer, to ultimately pick up the tab if the failures continue. Being one of those taxpayers, I suppose I, too, ought to share her sense of outrage at the "bailout" of Bear Stearns. However, I think the taxpayer shouldn't be looked upon as a blameless "victim" of rampant Wall Street greed.

Many of us (including yours falsely) in the fat and happy land of milk and honey, have been busily filling our pie holes and demanding a larger share of an economic pie that we expect will grow larger and larger until the sun burns out (or we croak, whichever comes first), and are complicit in fostering attitudes that institutions like Bear Stearns merely reflect. After all, Bear Stearns is nothing more or less than the collection of human beings who own and run it. It's not as if the legal fiction that is "Bear Stearns" could "strike a pose" or "have an attitude."

I think the crux of the problem with many aspects of American life is that many of us want, with a libertarian ferocity, absolute freedom of economic action and, simultaneously, an absolute freedom from suffering any adverse economic consequences as the result of those actions. Would Wall Street have idly stood by if Congress, state legislators, and/or federal or state regulators "stifled" their ability to create the subprime mess ("You're thwarting innovation and depriving the poor of access to credit and the American dream of home ownership.")? No, they would not, and they would have been supported by consumer advocates and many of the political and regulatory hacks who now are all over the "innovators" like Lindsay Lohan on a line of coke. As long as everybody was making money, home values were rising, and Americans were using their homes as self-replenishing piggy banks that would always be full, so that they could live the good life, here and now, there were "no worries, mate." If anyone in the government had moved to turn off that gushing spigot prematurely, they would have been crucified.

As the inevitable excesses unwind, does anyone really expect that the majority of the American public, even those who most heartily wring their hands about "moral hazards," would be willing to suffer the economic dislocation that would likely occur if the federal government didn't intervene (especially in a presidential election year) to cushion the blows so that the hot-house flowers that so many of us have become won't wilt under the severe recession that might very well ensue? It's great to teach the "big boys" lessons about "moral hazards" as long as I can still afford my Venti Caramel Macchiato and raspberry scone. The federal government is doing precisely what the average Jack and Jill wants them to do: "Make my life painless."

If the Bear Stearns "bailout" (and ask the employee-shareholders how $2.00-a-share sounds as a retirement plan) is symptomatic of a "moral hazard," it's a hazard that menaces more streets than "Wall." Try "Main."

Comments

[Guy]

Bravo!