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September 16, 2008

AIG, Risk Homeostasis, Moral Non-Hazard and Apollo Landings

I wish people would shut up about "moral hazard". Yes, bridging AIG through its current crisis is not something you want to do; and yes, it would be better if the market solved its own problem. But even a cursory analysts of the serpentine connections between AIG and capital markets tells you that the latter just can't happen, so you have to hold your nose, be an adult, and live with the former.

Moral hazard, while real sometimes and in some places, is vastly overrated as an effect. Granted, it's seductive in the same way that risk homeostasis is -- the notion that, for example, people drive faster and take more risks because they have seatbelts -- but like risk homeostasis, moral hazard is vastly over-diagnosed. People at major financial services outfits don't project five years into the future and say, "Lever up, boys and girls. We'll either make a lot of money now, or be bailed out later." Real people in real markets don't think that way. Matter of fact, if anything, they're short-sighted in that regard to a fault.

Further, imagining that people load up with "end of the world" liabilities in an effort to be anointed with "too big to fail" status is muddled non-thinking from run-amok conspiracy theorists. They would be better off sticking to, you know, perhaps denying the Apollo moon landings. Because the idea that a GM can now credibly post-AIG make the case that capital markets will blow up if we don't assist it too is silly -- and suggesting that auto companies (just to pick an example) will now plaster themselves with leverage bombs to make their own "We're dangerous too!!" case stronger is sillier still.

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