Moral Hazard

Moral Hazard


There is a much-aired notion, particularly in “liberal” circles in the United States, that those who have been financially reckless should be held to the fire in order to suffer the “moral hazard” of their actions. This Bible-thumping “fire and brimstone” idea must be working in their craniums at a subliminal level. Because, otherwise, it is of a piece with such out-of-date nostrums as: “from each according to his ability and to each according to his wants,” and other such Marxist babble.

While it is abundantly clear that the US financial sector and that of the developed world has been revealing gut-wrenching bad news with sickening regularity; it is equally true that the governments of all the affected countries are doing their utmost to stem the bleed. So far, they have been forced to write down more than USD150 billion in assets. And the International Herald Tribune estimates that the total write-offs to come, may yet amount to USD 600 billion. Still, to put it in perspective, the contemplated cost of this economic tsunami is trifling when compared to the cost of a war, even a limited, one country adventure, as one-sided as Iraq.

India’s financial markets, struggling suddenly with Sensex and Nifty levels of a year ago, brought about in 60 days from an all-time high; was thought to be decoupled from much of the carnage in the linked economies of the West. We are not in very deep with the convertible currency world’s banking systems. Nor do we mostly partake of its dominoes-style credit risk sharing ways. Also, we are not so dependent on exports except for the prominent IT sector and our domestic economy is in comparatively good shape. However, we have been psychologically feeding on Foreign Institutional Investor (FII) confidence to drive our markets. Our local conviction in the India story suffers from a typical, if sad, post-colonial inferiority complex. India is only good in Indian eyes, if the foreigner, especially the Western foreigner, says it is so.

So, since the Western foreigner is a little busy putting out his own economic fires, we are left rudderless and panicky. We are also further disheartened whenever the FII is forced to sell to make good losses elsewhere. In a matter of days, from a state of mental buoyancy, we find ourselves unable to take any succour from our plusses, as sentiment, such as it is, is ravaged. Witness, most recently, Bear Stearns, the erstwhile 5th largest investment bank on Wall Street, fire-selling Rs. 900 crores worth of Indian equities, catalysing a 950 point single day plunge in the Sensex.

But perhaps the tide is turning. Bear Stearns has been swiftly bought over by Morgan Stanley, albeit at 10 cents on the dollar, but backed by promptly provided American tax dollars. Also, two others, namely Lehman Brothers and Goldman Sachs, among Wall Street’s big five investment banks, have actually beaten performance expectations in their first quarter results. This, on top of yet another rate cut from the Federal Reserve, this time of 75 bps, is great for sentiment, and possibly growth, in a global marketplace cringing from one body blow after another.

But the true long term significance of every fresh piece of bad news and its aftermath is that a USD 14 trillion real economy (backed resolutely by its Western Allies and a few oil-rich Sovereign Funds), and a USD 23 trillion financial economy, similarly backed, is willing to stand up and be counted in every one of its critical hours. Thanks to this fact, the beleaguered economies of the world will be saved in 2008.

The rest of us, the emerging ones, should not complain, because we have someone to answer the ‘phone at 3.00 a.m., as we sleep. But perhaps Desi Dalal Street “Tigers” need to show some grit for a time. We have benefited shamelessly from five growth years on the trot on the back of FII exuberance, and should not grudge a limited period of pain. Since we manifestly cannot pull our own wagon, let us simply wait for the great FII driving engine to return.

But let us hope, meanwhile, that the advocates of the moral hazard line of economic thinking in the US do not gain any traction. They tend to be mercilessly unrelenting when it comes to the rich, the font, it is thought, of financial excess. The implication is that these well-heeled people are driven to diabolical excess by their insatiable greed and deserve to be brought down. That this category of “indiscriminate” lender to the “dodgy prospect” include transformational entities such as the World Bank and the International Monetary Fund is, of course, conveniently ignored.

These economic fundamentalists resent institutional and government action to shore up troubled banks, securities firms and lending institutions, oblivious to their enabling function. And now that they appear to be stumbling, and in some cases tumbling, in the United Kingdom, France, Australia, Japan and the United States alike, their antipathy only seems to grow. They demand that these banks and lending institutions should be left alone to stew in their own retributive juices. They want government largesse to flow “directly” and waiver-style to the hard-pressed defaulting borrower and the individual or family facing foreclosure.

These righteously indignant personages seem to have no fear of what can happen to an economy, indeed all the leading economies of planet earth, if its financial institutions are allowed to collapse. These latter-day keepers of the “true” economic faith have clearly chosen to ignore the Great Depression of 1929 which threatened the very anchor bolts of Capitalism, that too just twelve years after the Russian Communist revolution of 1917. They ignore the copious retrospective analysis that suggests that the Great Depression could have been totally avoided with a timely series of affordable bailouts to a small clutch of beleaguered banks on Wall Street.

The fact is the moral hazardists are resolutely against the kind of action that the US Federal Reserve Bank and the Treasury Department is taking now, again and again and as often as need be, to help the institutions survive and work to stimulate the economy afresh. But it makes you wonder which anarchist’s version of economics moral hazard expertise draws its inspiration from, and whether such apparent friends of the poor aren’t actually their worst enemies.

(1,050 words)

By Gautam Mukherjee
Wednesday, 19th March 2008

Also published in The Pioneer in the Leader Edit Slot on March 26th 2008 as"Moral Hazard? Ah Well..." see www.dailypioneer.com