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Great Depression Online Archive Issue:

A Moral Hazard of Epic Proportions

Great Depression Online
Long Beach, CA
December 11, 2007

Inside This Issue You Will Discover…

*** What’s a Moral Hazard
*** Moral Hazard Propagation
*** A Moral Hazard of Epic Proportions
*** And More

What’s A Moral Hazard?

A “moral hazard” is the idea that a person or party shielded from risk will behave differently than if they were fully exposed to the risk.

A person who has automobile theft insurance may be less careful about securing their car because the financial consequence of a stolen car would be endured by the insurance company.

Financial bail-outs, of both lenders and borrowers, by governments, central bankers, or other institutions, produce a moral hazard; they encourage risky lending and risky speculation in the future because borrowers and lenders believe they will not have to carry the full burden of losses.

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Moral Hazard Propagation

Do you remember the Savings and Loan crisis of the 1980’s?

The U.S. Government picked up the tab –   about $125 billion – when over 1,000 savings and loan institutions failed.

What you may not know is that the seeds were propagated by FDR during the Great Depression when he established the Federal Deposit Insurance Company (FDIC) and the Federal Saving and Loan Insurance Company (FSLIC). 

From then on, borrowers and bank lenders no longer had concern for losses – for they would be covered by the government. 

The Savings and Loan crisis confirmed this and further propagated the moral hazard of today’s subprime lending meltdown.

A Moral Hazard of Epic Proportions

Here we’ll quote a Reuters article, “Bush Unveils Plan to Stem Wave of Foreclosures,” we picked up on MSN on December 6, 2007.

“President George W. Bush announced a plan on Thursday aimed at slowing a wave of home loan foreclosures that has threatened to knock the U.S. economy into recession and rattled investors worldwide.

“Bush said the plan, hammered out by the U.S. Treasury Department in talks with mortgage industry leaders, was not intended to ‘bail out’ lenders, speculators or those who new they could afford the homes they bought.

“Instead, the Bush administration hopes that it can help more than half of the two million homeowners who took out adjustable-rate subprime loans with payments due to move sharply higher soon by offering some of them a five-year mortgage-rate freeze.”

We’ll pause here to ogle at the inherent absurdity of these statements.  We wish we were making this up, but our imagination is not that grandiose.

If freezing rates for five-years is not a bail out then we don’t know what is.

“Officials have said that 500,000 Americans are at risk of losing their homes as $367 billion worth of mortgages reset to higher interest rates over the next two years.  Expensive subprime loans traditionally are aimed at borrowers with weak credit, but increasing numbers of buyers took the loans as an easy way to hop into the market during the housing boom.”

There you have it…  A moral hazard of epic proportions.

To all those renters who didn’t hop into the market using a subprime ARM we have a cliché for your prudence: “No good deed goes unpunished.”  The message from all this seems to be that risky behavior is rewarded.

Who’s going to pay for this?

Here we’ll answer in Socratic Method, with another question: Have you looked in the mirror today?

That’s right.  You are.  Your taxes will cover some of it.  The rest will be papered over with inflation.

Sincerely,

M.N. Gordon
Great Depression Online

P.S.  We don’t know much about ETFs.  We don’t have the time or the dough to invest in them.  But if you’re interested in investing in ETFs, our friends over at the ETF Authority can help.  In fact, they’ve identified top ranked ETFs that mimic legendary billionaire Warren Buffet’s investment approach.  Learn more here.

 

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