John Authers’ piece in the Financial Times stating that the decade of moral hazard has ended provides a chance for us to look back on Lehman Brothers demise and the idea of moral hazard in a globally integrated society. On the 16th Authers stated that:
“In hindsight, this behaviour by banks was obviously irresponsible. The authorities' actions over the past weekend will doubtless be debated even longer than the LTCM rescue 10 years before, but that is the context for their decision. Lehman Brothers bankruptcy will not end the credit crisis. But it ends a decade of moral hazard. Nobody will again assume that the government will bail them out if they lend foolishly.”
While I would concur with Mr. Authers’ that the Lehman Brothers bankruptcy marks an end of an era, I would differ with him on the era that ended. I strongly believe that the failure of Lehman Brothers marks the end of lightly regulated financial markets both here and around the world. In the future, starting with the AIG bailout, the U.S. government will be an active participant in not only the financial markets but financial companies as well.
Furthermore, the very idea of moral hazard as it applies to a market or industry is suspect. If markets and industries are properly regulated, moral hazard should not occur. When it does occur the individuals who are involved, namely the employees of the company in question, face substantial risks should they undertake certain actions that attempt to pass risk up the food chain. The fact that Lehman’s management understood the actions that it did and still lost 100’s of millions of dollars for themselves and billions of dollars for their employees should not be overlooked.
The failure of Lehman Brothers pushed the world very close to the brink, all in an attempt to teach financial markets a lesson. I hope that the Bush administration realizes that there is a fundamental difference between eliminating common stock holders equity and terminating management teams and the placing of firms into bankruptcy to teach not only shareholders and management a lesson but the bondholders, customers and counterparties as well. In placing the bondholders, customers and counterparties at risk the Federal government allowed an intolerable amount of risk to be placed on the financial system.
The free market neo-liberalism that drove the world for the last several decades is dead and it is time that the Bush administration understands this and begin to implement aggressive policies that will save America’s financial system. Unfortunately, I fear that the failure of Lehman Brothers, coupled with a failure of AIG, if allowed by the Federal government, will mark the beginning of a prolong decline in the U.S. economy and the start of deflationary era similar to Japan’s predicament in the 1990s. We can only hope that the Federal Reserve’s bailout of AIG goes through. Even if it does, there will surely be a crisis around the corner whose severity we can barely imagine.
During the Great Depression Herbert Hoover was accused of doing too little, I fear that history will repeat itself if the Bush Administration does not step in to support the financial companies of America. The problems created by this administration, and its predecessors, through a chronic lack of regulation of the financial markets are what led to the failure of Lehman Brothers and the other disgraces that have marked our headlines this year.
At whatever the financial cost, America’s institutions must be protected by proactive government intervention to assure the continued prosperity of our country. In a world that is increasingly integrated, we cannot rely on a good cop – bad cop form of moral hazard where we punish the financial market and the people of the world for the incompetence of a select few. It is clear after the events of the last several weeks that sound institutions in conjunction with free markets and not free markets alone are the path to sound economic development and societal progress.
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