In the current climate of US Federal Reserve Bank and US Treasury actions to contain financial panics, we hear lots of lips and tongues flapping about the supposed "moral hazard" of helping when panic threatens to freeze up the financial system. These are the same people who are always hoping for a good old-fashioned debilitating depression to burn out the dead wood. Or perhaps they would logically criticize a fire engine company for responding to the site of a burning hotel full of innocent people because there was some suspicion that the hotel owners or operators were negligent.
The following is a snippet from a short article on the subject in Financial Times nearly a year ago, written by Lawrence Summers. Due to copyright issues I won't republish the entire article here, but you can safely sign up at the FT site to read for free occasional articles you come across which they have published. This part just below was emailed to me by FT:
BEWARE MORAL HAZARD FUNDAMENTALISTS
By Lawrence Summers, Published: September 23 2007 19:35 | Last updated: September 23 2007 19:35
Central to every policy discussion in response to a financial crisis or the prospect of a crisis is the concept of moral hazard. Unfortunately, there is great confusion in many quarters about the circumstances when moral hazard is, and is not, a problem. The world has at least as much to fear from a moral hazard fundamentalism that precludes actions that would enhance confidence and stability as it does from moral hazard itself.
The term “moral hazard” originally comes from the area of insurance. It refers to the prospect that insurance will distort behaviour, for example when holders of fire insurance take less precaution with respect to avoiding fire or when holders of health insurance use more healthcare than they would if they were not insured.
This article can be found at:
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Copyright The Financial Times Ltd 2008
A further snippet of the article was published Nouriel Roubini's site today:
"...prudent central banks will make judgments during financial crises not on the basis of “avoiding moral hazard” but rather by asking themselves three questions.
First, are there substantial contagion effects? Second, is the problem a liquidity problem where a contribution to stability can be provided with high probability or does it involve problems of solvency? Third, is it reasonable to expect that the action in question will not impose costs on taxpayers? If the answers to all three questions are affirmative, there is a strong case for public action."
