Thursday, October 2, 2008

risque moral

Root Cause

I've an annoying habit (to some), I'm always asking why, and always trying to figure out what the causal basis of situations (good, or bad) is. In attempting to understand the current financial crisis, my penchant for probing has lead me down the path that started out with people (mostly politicians) yelling "greed and corruption on Wall Street", "CEO's golden parachutes" "free-market run amuck", 'not enough regulation", "failed policies of the Bush Administration" , blah, blah, blah,blah!

But, despite the politicians attempt at obfuscation, I finally wound up at the real causal path of elements: Democrats pushing for targeted demographic votes, then pushing Fannie and Freddie to facilitate a prescription for ruin through lower and lower rate and risk policies; the Fed enabling this by pushing more and more money into the economy through lower and lower interest rates; "Wall Street" attempting to spread risk on these mortgages created  commercial paper derived (derivatives) from the mortgage based securities; and finally....Congress passing Sarbanes-Oxley, which has as an element, the kryptonite-like requirement for all this Super-Risk - the "mark to market' requirement that forced all these financial institutions to value their mortgage "derived" assets to zero due to the uncertainty over which ones had any element of a defaulted loan as part of it's base.  Whew!  Long sentence.

Along the way, I also learned about the Republican attempting to get the Democrats to rein in Fannie and Freddie, and the Democrats like Barny Frank, Chuck Schumer, and Rham Emanuel, successfully thwarting them. The fact that these same Democrats are pointing at the Republicans, Capitalism, Wall Street, and anything else that they can in an attempt to escape their rightful blame, is another story.  But the fact that they are the ones now architecting the solution to the problem that they caused, is part of this story, and very problematic.

Because, I've now been educated on the real ultimate causal element in this crisis: 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.
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.....

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?


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