Economics and Moral Hazard

Another first rate video from the Econ 101 series of the Center for Freedom and Prosperity.  This video exlores the concept of moral hazard in economics.  A moral hazard occurs in economics when one of the parties to a transaction is  insulated from bad effects if the transaction goes south.  This will cause that party to behave more recklessly than if the full impact of the failure of the transaction were felt.  Government bailouts of course establish a precedent that if a big business suffers a loss, that the government might bail it out.  No doubt many of our major financial institutions have learned the lesson that if a financial fiasco is large enough, Uncle Sucker will come to the rescue, and put the taxpayers on the hook for another few trillion that they can’t repay.  Moral hazard indeed!

6 Responses to Economics and Moral Hazard

  • Excellent! FNM/FRE provided huge volumes of (explosive) hydrogen (liquidity – relatively unlimited dollars chasing after limited houses) that over-filled the housing bubble, which is bursting (gov loan modifications and tax credits – just lapsed – will spread out the pain over years) so violently.

    N.B. FNM/FRE already cost “we the people” almost $300 billion. They are in conservatorship. They owe outright $1.6 trillion (publically held debentures – needs to be addded to the national debt) and also indirectly owe on implied guaranties possibly up to $10 trillion of mortgage backed paper.

    The 2,300 page financial reform legislation does not mention FNM/FRE. These are two dem sacred cows which ‘they’ apparently want to keep available to do more of the same damage going forward.

    Slight clarification: FNM/FRE lowered standards for loans they would buy to re-package/securitize into mortgage-backed securities. They also unsoundly increased the max loan balances they would buy. The banks would not have lowered credit underwriting standards if FNM/FRE had maintained their standards because banks would have retained the loans and the risks.

    Thank Dodd and Frank.

    A qualifier: Many (except ever-present frauds) involved parties believed that real estate prices always rise, never decline. So, they blindly accepted paper collateralized by any piece of God’s green Earth, regardless of the owner’s creditworthiness. The problem is that collateral values often disappear when they are most needed to cover loan losses. Appraised values (comparable sales prices not stabilized for unsustainable price run-ups) were used to the exclusion of sound credit underwriting and realistc financial analysis. Sadly, pension fund managers who have almost no real estate expertise but needed to “chase” yields and believed they were secured by good real estate collateral.

    President George W. Bush (Lord, I miss him!) didn’t do his duty here, either.

    In 1999, HUD Honcho A. Cuomo dictated that the two cash sacred cows underwrite 50% of their business in “low to moderate income” loans. The rate of home ownership rose from say (depending on the study) 63% to 69%, above historical equilibrium. Last I read, 15% of single family mortagge loans are past due.

    You just gored two lib/dem “sacred cows.”

    Anticipate lib ad hominems, insults and lies aimed at you.

  • T. Shaw I agree with most of what you posted – but I have found that the picture becomes MUCH clearer when the “liberal – conservative – Democrat – Republican” filters are removed. The bottom line is Wall Street runs our government – the politicians play the “two-party” false dichotomy when in reality that are two sides of the same coin, they just have different pet issues.

  • Great video! I like hearing someone say what I couldn’t express due to my lack of knowledge on the subject. But it seems all too simple now – follow the money trail…

  • Jim,

    Thanks. Most of that post was factual.

    The non-facts were meant to answer dem/liberals’ denials of sacred cows’ -FNM/FRE/HUD/US government social engineering – complicity in the recent economical “pomp and circumstances.”

    If the US had limited government and limited moral hazard, the depth of the debacle may have been limited.

    Also, recently, I believe Wall Street ceded its monopoly control of the US government to the UAW (GM/Chrysler bondholders were robbed), public employee/teachers unions, public pension funds, etc.

  • Question for Don: What is money?

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