Welcome to 'Moral Hazard'

Moral Hazard. It sounds like the name of a failed town in a Clint Eastwood western. We all live there now.

Until recently, "moral hazard" was heard only on the lips of insurance agents and over lunch in conservative think tanks. Both Fed Chairmen Alan Greenspan and Ben Bernanke have uttered the phrase "moral hazard" in front of congressional committees to warn against excessive financial risk. Senators and members nod, look down at their cheat sheets and think, "Mmm, right, moral hazard."


CorbisNow, with big banks dropping like flies and Wall Street vaporizing amid a mortgage meltdown, every corner bar and hair salon is filled with experts on the perils of moral hazard. Everyone gets it: Cut risk down to next to nothing and some people do crazy things.

Borrowers across America took a dive for low- or no-down-payment mortgages buoyed by the Federal Reserve's low-risk interest rates. Wall Street sliced the mortgages thinner than prosciutto ham, "spreading risk," and sold pieces all over the world, where, like magic, they seemed to fatten balance sheets. The deal was so win-win that Bear Stearns, Lehman, Merrill and the rest of the world's mega-banks engorged on their own product. It was as if foie gras geese forced corn and fat down their own throats. The risk of exploding seemed to be nil.

For behind it all sat Fannie Mae and Freddie Mac, running mortgage liquidity into the nation's neighborhoods like an open fire hydrant. Several years ago, when the Journal's editorial board met with Fannie Mae's top executives and pressed the issue of financial risks, we were told by way of ending the conversation that Fannie was merely fulfilling the "mandate of Congress" to spread home ownership across the land. Congress, of course, is a temple to moral hazard.

"Moral hazard" is an odd phrase. Its meaning isn't obvious though it does sound like something one ought to avoid. "Moral hazard" dates back hundreds of years in obscurity, but its use eventually settled inside the insurance business in the 19th century. The French call it risque moral.


Wonder Land columnist Daniel Henninger tells Kelsey Hubbard that discussions of responsibility and the financial crisis should be held in the context of the presidential debate. (Oct. 2)
Back then, it really was taken to mean that reducing risk too much exposed people to the hazard of poor moral judgments. If an insurer charged too little for a policy to replace farms in the English countryside, Farmer Brown might be less careful about cows knocking over oil lamps in the barn.

In time, the economists got their hands on "moral hazard," and the first thing they did was strip out the heavy moral freight to make the concept value-neutral. Now moral hazard became less about judgment and more about the economic "inefficiencies" that occur in riskless environments.

We're back to the original meaning. Losing tons of money for an institution is an economic inefficiency. Lose the nation's financial structure, however, and moral fingers get wagged.

John McCain and Barack Obama are ranting about greed. Congress is taking the air out of golden parachutes. Republicans in Congress are getting pushback from constituents on Main Street who object to "bailing out" banks and what's left of Wall Street.

With so much economic loss and ruin being booked on such a grand scale, it's normal to assign blame. Yes, politics ought to fight its way toward knowing how mortgage-backed securities led to this.

I'm wondering, though, if the U.S. hasn't arrived at a large Pogo Moment. With the greatest financial crisis since the Depression, have we finally met the enemy, and does it turn out that the enemy is us?

For all the wailing about the high price being paid now of ignoring manifest risk beneath the mortgage crisis, are we angry at bad decisions that must never be repeated, or just upset that it all blew up? Because if it's the latter, politicians will try to game the system again to get more risk-free benefits.

Even as it passes through the greatest moral-hazard demonstration in history, Congress this week approved, and President Bush signed into law, a $25 billion "loan" to the auto industry. Without a peep of objection from anyone.

Because no creditor will run the real risk of lending Detroit money, Washington will not only make another $25 billion liar loan but do it so the industry can somehow conjure up Congress's mandated alternative-fuel cars. Are we nuts? Absent the discipline of normal risk, why won't this blow up too?

This subject -- risk and political moral hazard -- should be at the center of our derailed presidential campaign and its debates. Liberals don't like to hear moral-hazard arguments raised against social-policy goals. The current mortgage nightmare, however, grew primarily from Congress's insistence on increasing home ownership by reducing its risks.

Barack Obama's core proposals on health insurance, trade policy and tax credits all seek to reduce an array of economic risks. John McCain's ideas on health, education and the tax code tilt toward "choice," or letting individuals make judgments about economic risk-taking.

Most of the time, moral hazard is simply academic. Not after this week. Our presidential candidates should have a talk about it.

Esto se les paso por la huacha a los funcionarios federales americanos. Obviamente este es una falla de mercado porque hay un problema de informacion, la informacion es asimetrica. En el "Principal-agent problem" hasta los mas dogmaticos saben que se tiene que regular, sobretodo en un mercado donde se juegan trillones de dolares.
El moral hazard tambien puede presentarse a nivel de paises como le paso a Argentina en el 2001. Despues de la farra fiscal, esperaba que el FMI lo salve, pero al final el FMI no lo salvo y cayo en una profunda crisis economica y politica