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Explain Moral Hazard to Me Like I'm a 2-Year-Old

Posted March 14, 2023

When I was a new father some 22 years ago, I read all those books you're supposed to read, like What to Expect When You're Expecting.  

There was one bit in particular where it said you can’t spoil a baby, and the book had all these studies to prove it. For some reason, I thought you could by picking them up too much and whatnot.

However, this book pointed out that until you are a toddler, you don't understand that actions have consequences. A toddler craves rules and boundaries to give order to their world. As a dad, you don’t want them to lick the outlets or eat the dog food.

Banking Bailouts - Moral Hazard

This brings us to the economic idea of moral hazard. Moral hazard refers to the concept that people or institutions may take on more risk than they otherwise would because they know they will be protected from the consequences of failure. 

People who free-climb rock faces are more careful than those who wear helmets and use ropes, harnesses, and other safety gear.

For example, if a bank, say Silicon Valley Bank, knows that the government will bail it out if it fails, it may take on riskier investments than it otherwise would because it knows it won't suffer the full consequences of failure.

In the Great Recession of 2008, we heard a lot about privatizing risks and socializing responsibility. This is what they were talking about.

It All Goes Back to the Fed

Over the past three decades, the Federal Reserve has responded to every economic crisis with bailouts and money printing, from the savings and loan crisis of the 1980s and 1990s through the dot-com bubble, the post-9/11 airline bailouts, the Great Recession, and, of course, the COVID pandemic.

The rationale behind these bailouts is that the failure of a large bank could have catastrophic consequences for the entire economy, so it's better to bail out the bank and prevent a larger economic collapse.

Any parent worth their salt would tell you that this is wrong. It is short-term thinking. In reality, we want the banks to fail, to take the hit. We want the hotshot private jet ESG BS artists who’ve been pushing SPACs, IPOs, and unicorns over the last five years to take it on the chin — hard.

These are the Wharton MBAs, the VCs, the tech leaders. They donate to the right causes and talk the right talk. They aren't a 2-year-old who's learning the ropes. They are the sharks. They know what they are doing and know, push come to shove, they will get away with it.

And every cycle it gets worse. The bailouts get bigger. The national debt grows.

Today, the market is up because Wall Street thinks the Fed can’t raise rates anymore. It will have to cut rates. High rates already killed two banks with bad debts, and, like cockroaches, there are bound to be more out there hidden in the dark.

Banking bailouts protect banks from bad choices, but what’s worse is those same people who made a lot of money playing games at Enron, AIG, and PricewaterhouseCoopers just set up shop somewhere else and did it all over again.

After all, it ain’t their money.

All the best,

Christian DeHaemer Signature

Christian DeHaemer

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Christian is the founder of Bull and Bust Report and an editor at Energy and Capital. For more on Christian, see his editor's page.

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