Creating Moral Hazard

Cost of Government Center ^ | 2012-04-29 | [Staff]

[92nina]

When prominent Democrats maintain the philosophy that government should never let a serious crisis go to waste it’s no surprise that they assume government has to react to every market hiccup, particularly after the Great Recession. What they don’t think about is perhaps doing nothing is as good as, if not better than drafting expansionist policies.

JP Morgan’s much maligned $3 billion hedging failure is the crisis of the day and there hasn’t been a shortage of pundits and Democratic policymakers who urge action in the face of this “crisis.” Paul “Blame Bush” Krugman wrote that the situation means reform measures must be taken to limit depositor exposure to risky hedges and derivative trades.

In an apples and oranges comparison, Krugman scales down JP Morgan’s situation to the It’s a Wonderful Life level. He asks the question what if the town’s savings and loan enterprise—Bailey Building and Loan—had bet depositor funds on risky investments like JP Morgan?

To his credit, Krugman mentions the nature of moral hazard here—that FDIC insured deposits allow investors’ taxpayer funded coverage in the event of a bad hedge that takes down the bank. But this gets to COGC’s views on the negative influence of government in private markets.

COGC’s most recent Cost of Government Day Report features a case study on Dodd-Frank that shows how government insurance incentivizes risk. Since their bets are essentially covered by taxpayers, brokers and fund managers use less discretion when investing depositor funds—the firm encourages this because it doesn’t face the true cost of the riskiest investments. And since we’re talking apple and orange comparisons, the same thing happens in government healthcare and social security (a redistributive form of retirement insurance).

It’s time to get the government out of the private markets and force individuals to face the true cost of risks—both in healthcare and private investment. The answer isn’t, as the left likes to claim, more regulation. It’s getting government out of the business of business—eliminate the moral hazard and investors will quickly change behavior because they, instead of taxpayers, will have to face the risk.

[92nina]

Government insurance incentivizes risk creating a moral hazard backed by taxpayer dollars.

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