Moral Hazard

Everybody loves to preach. People who live in glass houses love to throw stones at others. Either that, or the term “moral hazard” is impossibly hard to live up to in the world of finance. Wait, moral what? Put simply, it means if you take a chance with money, it may not pay off. You might lose money, you should know that and so don’t start crying and bawling if things don’t work.

Steve Waldman tears into the EU for behaving as if they’d never heard of the concept when dealing with Greece:

“Lending to a corrupt, client list Greek state that squanders resources on activities unlikely to yield growth from which the debt could be serviced? That is precisely, exactly, what the term “moral hazard” exists to discourage. You did that. Yes, the Greek state was an unworthy and sometimes unscrupulous debtor. Newsflash: The world is full of unworthy and unscrupulous entities willing to take your money and call the transaction a “loan”. It always will be.”

Waldman’s right. But the same should have applied to the US institutions during the 2008 financial crisis. Yet, the US bailed out its banks and financial institutions in 2008. Moral hazard wasn’t on the US government’s lips back then.

Next take stock exchanges. If you invest in shares, you are taking a risk. Yet when the Chinese stock market crashed by more than 30% within the last month or so, how did Beijing react? No, not by reminding investors of moral hazard. Instead it suspended trading in 72% of shares and prevented anyone with more than 5% shares in a company from selling them. Eliminate the trading and be definition, prices can’t fall!

Like I said at the beginning, everyone likes to preach to others. But practicing what they preach? Not so much.