Tuesday, September 16, 2008

Moral Hazard

"We've re-established 'moral hazard,'" said a person involved in the talks, referring to the notion that the government should eschew bailouts, since financial firms might take more risks if they're insulated from the consequences. "Is that a good thing or a bad thing? We're about to find out."

Ultimatum by Paulson Sparked Frantic End - WSJ.com

This was in reference to the Federal government in the US allowing one of Wall Street's major financial institutions, Lehman Brothers, to fail and file for bankruptcy. Financial markets tumbled all over the world.

In Kuwait the stock market did not fare any better tumbling for the past days wiping out gains accumulated over many years. One culprit is the extension of the international financial crisis resulting from the burst of the housing bubble in the US. This led many foreign institutional investors to cash out of emerging markets in an attempt to solidify their financial position, which led to this sharp decline among other reasons.

No one is enjoying this mayhem but there are important lessons to be learned. Most important is the concept of moral hazard. People put their money in high risk expecting no downside. If things go sour they expect the government to intervene as they do now. This encourages risky behavior. However, if they get their fingers burnt, more than fingers at the current rate, then they will behave more carefully in the future. When the wind is blowing even turkeys fly. It's time to come back to earth.

3 comments:

bu ziyad said...

“Uncertainty is the only certainty there is, and knowing how to live with insecurity is the only security,” wrote mathematician John Allen Paulos.

I found this in FT/Lex column. I thought it was worthwhile.

Cranberry said...

"When the wind is blowing even turkeys fly"

That's why the US celebrates thanksgiving! I think its time we all sit down on the table and give thanks to what we have and stop being so greedy always wanting more

bu ziyad said...

Cranberry: Amen!