More Members of "Shut Up About Moral Hazard" Club

Nice editorial in today’s Times of London echoing my prior comment here that people need to shut up already about "moral hazard".

Having learnt the term, people tend to get a great deal too excited about moral hazard, the idea that by compensating people for the cost of their own reckless behaviour you encourage similar behaviour in the future. The US Federal Reserve was accused of ignoring moral hazard when it helped JPMorgan Chase to rescue Bear Stearns. As if arranging for shareholders to get $2 a share for stock with a book value of $80 would encourage reckless lending in future.

Last weekend, the Fed refused to support Lehman Brothers partly on the grounds of moral hazard. Once again, the risk of encouraging bad behaviour seemed pretty modest compared with the risk to the wider financial system. The collapse of Lehman turned out to be very damaging, accelerating the implosion of AIG and the panic over Goldman Sachs and Morgan Stanley.

As Charles Goodhart said in the FT this week, the time to worry about moral hazard is in the boom. Worrying about moral hazard now is like “refusing to sell fire insurance just after the Great Fire of London for fear of adversely affecting future behaviour”.

I like John Hempton’s Marshall Plan metaphor better, but the point stands. More here.