Wednesday, September 17, 2008

Where does moral hazard end?

Moral hazard, the problem of behavior changing with the response of the government to the credit crisis, surrounds us as we swirl through this crisis, but at the same time there is a significant lack of clarity on when the government will step in a protect investors. The future actions on what type of risk taking should be undertaken is unclear.

If you are a broker-dealer there is no safety net unlike some of the help given institutions during the LTCM crisis. You are on your own. See Lehman brothers and Bears Stearns. If you are a bank, you have more protection because the Fed will provide you with funds. See the amount of liquidity provided through the Fed.There were some protections for financial institutions from naked short selling. A large insurance company, like AIG, gets taken over by the government. This one was too big to fail. Hard to say what will happen to other insurance companies. The large GSE's get the help of the government. Shareholders and top management hurt but the rest of the show goes on.

But what about GM or Ford who have thousands of workers? What about money funds? What about mid-tier banks? The issue with the term moral hazard is that it is not clear how some of the government actions will play out and with whom. The uncertainty is still present and the "bail-outs" do not solve the confidence problem.

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