Simon Johnson, Kwak on Moral Hazard

Remember the entire concept of moral hazard in bailing out private institutions who done it to themselves? Remember how that backfired on Lehman Brothers?

In Lehman Brothers and the Persistence of Moral Hazard, Simon Johnson and James Kwak point out moral hazard was already built into the system through these three main points:

  • bank employees and managers had asymmetric compensation structures
  • Second, shareholders had the same payoff structure
  • creditors had only limited incentives to watch over major banks

Then, they continue with proposals for financial reforms:

If the Obama administration is serious about preventing a future financial crisis, it will have to address these three forms of moral hazard. However, its proposals may not be adequate to the task.

It's a very good read, their Lehman Brothers anniversary post. But isn't it astounding no real reforms have been enacted even though it's a year later after Financial Armageddon?

Reminds me of the 9/11 commission recommendations, sitting around, gathering dust 8 years later.

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Moral Hazard

It seems that the government has accepted moral hazard as a cost of doing business. The implicit policy is to resuscitate the banks by providing cheap liquidity until the spread has rebuilt their capital base. FDIC guarantees provide relatively cheap money, and rates stay down. CD rates quoted by major banks are about in line with Treasuries, but banks are going for all the fee income they can get. Guess who is paying for this?
Frank T.

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Frank T.