The time to worry about creating a moral hazard is when it's hardest

The most recent casualty in the never-ending credit crisis is IndyMac (times like this I'm glad the FDIC exists). There has been a great deal of talk of Freddie Mac and Fannie Mae going under. As Steve Pearlstein over at the Washington Post says, "We're nearing that delicate point in the cycle when even the usual cheerleaders have hung up their pompoms...".

However, the overall gist of his article culminates in one final paragraph:

"A financial crisis is not a morality play. What matters most isn't the precedents that are set, the amount of taxpayer money that's implicated or whether people are made to suffer fully for their financial misjudgments. In the end, what matters most is that we get through it as quickly as possible with an economy and a financial system intact."

I somewhat agree. There's no point in going out of your way to punish people for what you see as excessive greed. However, that's not really the concern. The concern is that taxpayer resources, either explicitly taken through taxation or implicitly through Fed money creation, are used to bail out institutions which brought destruction on themselves.

Nobody likes to hear it, but TANSTAAFL (there ain't no such thing as a free lunch).
During any crisis, there is a real temptation to do whatever is necessary right now and forget about the long term consequences. That is what Pearlstein is advocating. That type of attitude might lessen this crisis, but it inevitably bring about another one (check out this article on how this happened with Fannie Mae and Freddie Mac). It is shortsighted and frustrating.

The "bailout" of Bear Stearns is roughly how these things should go. The employees, and especially the shareholders, got royally screwed. Many employees obviously had no hand in the activities which led to a downfall, but when you work at a company you know your job security is dependent on more than just your performance, and the shareholders knew what risk they were taking. Whether the cost to the taxpayer (up to $29 billion) was justified remains to be seen, but there was no moral hazard created by this action*.

The only time when new structures can be put in place to minimize the boom-bust cycle is during the bust. During the boom, it's called anti-business. Now is the time when we need to focus our efforts on maintaining the long-term health and well-being of our populace, and if that means the complete destruction of our present financial system (it almost certainly doesn't, but painful reforms are likely necessary), so be it.

So, Mr. Pearlstein, I give you an error rating of 2. I know you mean well, and you're not totally wrong, but your priorities are a bit out of whack.

-Enginerd


*What many don't realize is the only people who got bailed out were Bear Stearns bondholders, i.e., people that lent them money. This is what will happen if the GSEs need bailing out. However, since the GSEs have $5 trillion of debt owned or guaranteed, that's basically everybody. For reference, the value of all publicly traded companies in the US was $20.5 trillion as of March 2007 (Seeking Alpha), so we're talking real money here.