moral hazard

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pages: 444 words: 151,136

Endless Money: The Moral Hazards of Socialism by William Baker, Addison Wiggin

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Library of Congress Cataloging-in-Publication Data: Baker, William W. Endless money : the moral hazards of socialism / William W. Baker. p. cm. Includes bibliographical references and index. ISBN 978-0-470-47615-4 (cloth) 1. Monetary policy. 2. Banks and banking. I. Title. HG230.3.B354 2009 330.15’7—dc22 2009021625 Printed in the United States of America 10 9 8 7 6 5 4 3 2 1 For my wife, Maris; our children, Chase and Ian; and all our family and descendants to come… Contents Foreword Introduction ix xiii Part 1: The Calm before the Storm Chapter 1 Chapter 2 Chapter Chapter Chapter Chapter 3 4 5 6 Chapter 7 Chapter 8 Unknown Unknowns Wings of Wax 1 3 18 Part 2: Endless Money 33 The Rise and Fall of Hard Money Flat-Earth Economics Spitting into the Wind Moral Hazard 35 70 116 135 Part 3: Faux Class Warfare 163 The Rich are Different from You and Me Sharecroppers 165 188 vii viii CONTENTS Part 4: Assuming Power Chapter 9 The Heart of the Financial System Chapter 10 A Return to Malaise Chapter 11 Democracy: The Achilles’ Heel of Capitalism?

If it isn’t standard economic theory, then it’s plain old common sense. To claim that it simply doesn’t exist in the Moral Hazard 145 textbooks is to admit you are intentionally blind, for to see it would be to point the finger at those who are truly to blame for this mess. In the immortal words of the originator of the comic strip Pogo, Walt Kelly, “We have met the enemy . . . and he is us.” Wall Streeters who clamor for government intervention are like vultures eating at the financial carcass, but they would have us believe they are doctors trying to resuscitate the patient. The sharp difference on expected outcomes crafted by socialists and conservatives is attributable to how each estimates the behavioral aspects of the problem of moral hazard. The former ignore this effect, thus enhancing the chance of systemic destruction; the latter attempt to stave off disaster through strongly incentivizing market participants to be risk-proof.

Socialism’s solution to the housing crisis is reminiscent of the Japanese perpetual recession, where a bear market in equities has run 19 years and counting. The moral hazard that has been built into the nation’s mortgage market is a function of the structure of the system, something that the liberal Keynesian economist Paul Krugman drives home in his nostalgic plea to return to a simpler, 1950s-style banking system. While this is true, it demotes the importance of Democrat-inspired programs that tilted the playing field to incentivize origination of mortgages on behalf of those with poor credit, and it also ignores the role of wrapping a government guarantee around this compromised product. When all is said and done, securitization and lack of regulation will be blamed Moral Hazard 147 for much of the trouble in the real estate market and the credit market in general.


pages: 566 words: 155,428

After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead by Alan S. Blinder

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Paulson, who was both a Republican and a markets man who formerly ran Goldman Sachs, was perhaps overly concerned about the moral hazard issue in the aftermath of Bear Stearns. Still, he had a point. Public funds had been deployed to save Bear, Fannie, and Freddie. If they were now made available to Lehman, it would imply—once again—that the U.S. government was waiting in the wings to bail out any major financial institution. Moral hazard would have proliferated, and Mr. Paulson would, indeed, have become Mr. Bailout. But, of course, he became Mr. Bailout, anyway. These thoughts, valid as they were, represent only one side of the moral hazard ledger, however. In simplest terms, the tradeoff looked like this: On one side, saving Lehman would deepen an existing moral hazard problem. On the other side, Bear Stearns had been rescued, moral hazard notwithstanding, in order to stave off possibly serious contagion to a wide variety of innocent bystanders—perhaps as many as 310 million Americans.

But they are watching and waiting for either a buoyant economy or signs of inflation before they head for the exits. Neither seems imminent. The Ghost of Moral Hazard Past One of the least desirable legacies of the emergency measures of 2008 and 2009 is the creation of moral hazard everywhere. Bailouts, rescues, guarantees, and the like succeeded in saving many investors, companies, and even some executives and traders from oblivion. The moral hazard ayatollahs notwithstanding, doing so was not a mistake. Had we stood firmly on the anti-moral–hazard high ground, our principles would have emerged unscathed but our economy would not have. Necessity mothered pragmatism. But moral hazard is now an undesirable feature of the financial landscape. One important aspect of Never Again is convincing financial markets that the government will not rescue them from future mistakes.

JP Morgan’s board minutes later revealed that they had reduced their $4 bid to $2 “because the government would not permit a higher number . . . because of the ‘moral hazard’ of the federal government using taxpayer money to ‘bail out’ the investment bank’s shareholders.” The purchase price was later raised to $10 a share to ensure that Bear Stearns’ shareholders would not vote the “merger” down. Behind the scenes, and invisible to almost everyone, the details of the shotgun marriage that had been hurriedly arranged that Sunday then took about three months for all to agree on. THE MORAL HAZARD DEBATE “Moral hazard” is one of those awkward phrases that is not self-descriptive. In particular, the term, which is borrowed from the insurance industry, has nothing whatsoever to do with morality. Rather, it’s about incentives for risk taking, and how people may respond to them. The central idea behind moral hazard is that people who are well insured against some risk are less likely to take pains (and incur costs) to avoid it.


pages: 593 words: 189,857

Stress Test: Reflections on Financial Crises by Timothy F. Geithner

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The prospect of a similar “rescue” was not much comfort to other systemic firms or potential investors; Bear ceased to exist and its shareholders lost a fortune. The moral hazard theorists simply underestimated the mania, the power of Hyman Minsky’s theory, which I first read in 2007, that stability can breed instability. That said, moral hazard was a legitimate problem. Fannie and Freddie exploited their access to cheap capital—a result of the widespread (and ultimately correct) assumption that the government would stand behind their obligations—to take on way too much leverage and risk, a classic example of moral hazard. The large banks also enjoyed lower-cost financing because of their access to a government safety net, which was one reason they got so large. And there was a real danger that moral hazard created by our actions to resolve this crisis could plant the seeds of a future crisis.

It seemed obvious to me that in a moment of extreme vulnerability, haircuts would only intensify the crisis, but Sheila didn’t see it that way. She was determined to guard against moral hazard and protect the FDIC insurance fund. She saw this as a teachable moment, a chance to show the world that the irresponsibility of WaMu and its bondholders would be punished. She made the same argument the Germans and other moral hazard critics had made against IMF assistance during the emerging-market crises: It will only encourage bad behavior in the future. I thought that in the midst of the worst panic any of us had ever seen, any effort to minimize FDIC losses through haircuts in an individual case would lead to more bank failures and much bigger FDIC losses down the road. More failures would eventually require more aggressive government interventions, creating more moral hazard rather than reducing it. I couldn’t understand why the risks in allowing WaMu to default on its debts weren’t completely obvious, especially after Lehman’s default had paralyzed credit markets and shocked the world.

It can endanger strong as well as weak institutions, because in a stampede, the herd can’t tell the difference; that’s basically the definition of a financial crisis. Old Testament vengeance appeals to the populist fury of the moment, but the truly moral thing to do during a raging financial inferno is to put it out. The goal should be to protect the innocent, even if some of the arsonists escape their full measure of justice. Our approach did create some moral hazard, although the critics I came to call “moral hazard fundamentalists” tended to overstate our generosity to failed risk-takers. Shareholders in the five bombs had already absorbed huge losses; the leaders of Fannie, Freddie, and AIG had been pushed out; Lehman had ceased to exist. But the larger point, as President Obama later said, was that you shouldn’t refuse to deploy fire engines to a burning neighborhood in order to highlight the dangers of smoking in bed.


pages: 309 words: 95,495

Foolproof: Why Safety Can Be Dangerous and How Danger Makes Us Safe by Greg Ip

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Jacques, “Society on the Basis of Mutual Life Insurance,” 16 Hunt’s Merchants’ Magazine (1849): 152, 153, quoted in Tom Baker, “On the Genealogy of Moral Hazard,” Texas Law Review 75, no. 2 (1996): 247, available at https://www.law.upenn.edu/fac/thbaker/Tom-Baker-On-the-Genealogy-of-Moral-Hazard.pdf. 2 Thai Life Insurance: It can be viewed here: https://www.youtube.com/watch?v=IkOGwdxcwaw. 3 which stipulates that a man: David Rowell and Luke B. Connelly, “A Historical View of the Term ‘Moral Hazard,’” Geneva Association Insurance Economics Newsletter, January 2012, available at https://www.genevaassociation.org/media/178212/ga2012-ie65-rowellconnelly.pdf. 4 The term “moral hazard”: Rowell & Connelly, “A Historical View.” 5 Children’s advocates: V. A. Zelizer, “The Price and Value of Children: The Case of Children’s Insurance,” American Journal of Sociology 86 (1981): 1042. 6 moral hazard and the Peltzman effect: My interview. 7 Car insurance does seem: For auto insurance see Alma Cohen and Rajeev Dehejia, “The Effect of Automobile Insurance and Accident Liability Laws in Traffic Fatalities,” NBER Working Paper 9602, April 2003, available at www.nber.org/papers/w9602.pdf.

Yet at the time, it is also clear that some officials thought letting it fail would serve a useful purpose: it would purge the financial system of the moral hazard that the rescue of Bear Stearns had created and that had drawn reproof from many quarters. Over the course of the summer, Treasury had tried to make it clear that no similar rescue would await Lehman. Inside the Fed, feelings were more conflicted; Tim Geithner, president of the New York Fed, was adamant that the Fed should keep the bailout option open, but some staffers agreed that bankruptcy was better than a bailout. One staffer said the Fed must not contribute its own money to assist a takeover of Lehman as it had with Bear Stearns because the “moral hazard and reputation cost is too high.” Letting Lehman go bankrupt would be a “mess on every level, but fixes the moral hazard problem.” Bernanke and Hank Paulson, the Treasury secretary who would have had to sign off on a bailout, felt similarly.

In the 1800s, with better statistical tools, insurers began to differentiate risks, for example, requiring medical exams for life insurance. The term “moral hazard” first appears in the 1860s, in The Practice of Fire Underwriting, wherein it was defined as: “the danger proceeding from motives to destroy property by fire, or permit its destruction.” As the term suggests, moral hazard has long been linked to debates about right and wrong. In the nineteenth century, parents, who benefited from their children’s labor, sometimes bought life insurance policies on their children. Children’s advocates thought the practice repellent and warned it was incentive to parents to neglect or even murder their children. When economists in the 1960s began studying moral hazard, they gave it a more neutral, even positive character: it was simply the product of incentives.


pages: 249 words: 66,383

House of Debt: How They (And You) Caused the Great Recession, and How We Can Prevent It From Happening Again by Atif Mian, Amir Sufi

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Andrei Shleifer, asset-backed security, balance sheet recession, bank run, banking crisis, Ben Bernanke: helicopter money, Carmen Reinhart, collapse of Lehman Brothers, debt deflation, Edward Glaeser, en.wikipedia.org, financial innovation, full employment, high net worth, Home mortgage interest deduction, housing crisis, Joseph Schumpeter, Kenneth Rogoff, liquidity trap, Long Term Capital Management, market bubble, Martin Wolf, moral hazard, mortgage debt, paradox of thrift, quantitative easing, Robert Shiller, Robert Shiller, school choice, shareholder value, the payments system, the scientific method, tulip mania, young professional

Just like the trader on the Chicago Board of Trade floor, many believe that government intervention encourages moral hazard—households must be made to suffer so that they never again borrow so aggressively. As we discussed in chapter 6, many home owners during the boom did indeed treat their homes as ATMs and spent more as a result. As economists with a strong background in the optimal design of financing arrangements, we have a deep appreciation for moral-hazard concerns. But in this case, we’re not dealing with moral hazard. Moral hazard refers to a situation in which a sophisticated individual games a flawed system by taking advantage of a naive counterparty. The classic example of moral hazard is someone driving irresponsibly after getting auto insurance because he knows the insurance company will pay for an accident.

If the auto insurance company naively provides unlimited insurance at a cheap price, the driver’s moral-hazard problem could become quite severe. This does not explain what happened during the housing boom. Home owners were not sophisticated individuals who took advantage of naive lenders because they understood house prices were artificially inflated. They weren’t counting on a government bailout, and indeed they never received one. In reality, home owners mistakenly believed that house prices would rise forever. Perhaps this was a silly belief, but the image of a sophisticated home owner gaming lenders and the government is wrong. If anything, sophisticated lenders may have taken advantage of naive home owners by convincing them that house prices would continue to rise. Moral hazard doesn’t fit for another reason: the decline in house prices was beyond the control of any home owner in the economy.

Yet this responsible home owner, through no fault of his own, experienced the complete loss of his home equity from 2006 to 2009 and was pushed way underwater by the 60 percent decline in house prices. How is the loss of wealth the home owner’s fault? Why should he be punished? Such massive aggregate shocks are not any one individual’s fault and are therefore not well described by the notion of moral hazard. Moral hazard also does not easily apply to the main policies we advocate, because they are not wholesale taxpayer-funded bailouts of home owners. Instead, we advocate a more even distribution of housing losses between debtors and creditors. Is a more even distribution “unfair”? Remember, it is not a wealth transfer to a guilty party from an innocent one. Both home owners and creditors were culpable in driving the housing boom.


pages: 576 words: 105,655

Austerity: The History of a Dangerous Idea by Mark Blyth

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accounting loophole / creative accounting, balance sheet recession, bank run, banking crisis, Black Swan, Bretton Woods, capital controls, Carmen Reinhart, Celtic Tiger, central bank independence, centre right, collateralized debt obligation, correlation does not imply causation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, debt deflation, deindustrialization, disintermediation, diversification, en.wikipedia.org, ending welfare as we know it, Eugene Fama: efficient market hypothesis, eurozone crisis, financial repression, fixed income, floating exchange rates, Fractional reserve banking, full employment, German hyperinflation, Gini coefficient, global reserve currency, Growth in a Time of Debt, Hyman Minsky, income inequality, interest rate swap, invisible hand, Irish property bubble, Joseph Schumpeter, Kenneth Rogoff, liquidationism / Banker’s doctrine / the Treasury view, Long Term Capital Management, market bubble, market clearing, Martin Wolf, moral hazard, mortgage debt, mortgage tax deduction, Occupy movement, offshore financial centre, paradox of thrift, price stability, quantitative easing, rent-seeking, reserve currency, road to serfdom, savings glut, short selling, structural adjustment programs, The Great Moderation, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, Tobin tax, too big to fail, unorthodox policies, value at risk, Washington Consensus

Yet in doing so, it mistakes the mechanisms that generate trust—diffuse reciprocity, norms of mutual aid, and so on—for naïve weaknesses that can only be eliminated by more rules and stronger sanctions: exactly the things that eliminate the possibility of trust. While social capital does not trump moral hazard per se, when policy makers view all mutual interactions as agency problems, where one party will inevitably take advantage of another, the only solutions imaginable are the elimination of institutional ambiguity, the tightening of rules, and the writing of superficially complete contracts—which looks a lot like current Eurozone reforms. The problem is that what economists call moral hazard is what normal people call trust. You cannot eliminate the former without destroying the capacity for generating the latter. Without some degree of rule ambiguity and norms of reciprocity, trust cannot emerge. The EU’s political project was built on trust, not the elimination of moral hazard. That’s why it worked. Its monetary project is based on opposite principles.

But why did these bond buyers believe that this new and untested institution, the ECB, would in fact guard the value of their bonds, that national governments didn’t matter any more, and that Greece was now Germany? The answer was, they didn’t need to believe anything of the sort because arguably what they were doing was the mother of all moral hazard trades. Figure 3.2 Eurozone Ten-Year Government Bond Yields Source: European Central Bank Statistical Data Warehouse The Mother of All Moral Hazard Trades If you were a European bank back in the late 1990s seeing sovereign bond yields falling, it might have bothered you since a source of risky profits was disappearing. On the other hand, if this new ECB gizmo really did get rid of exchange-rate risk for the sovereigns issuing the debt and take inflation off the table by housing in Frankfurt the only money press in Europe, then it really was a banker’s dream—a free option—safe assets with a positive upside, just like those CDOs we saw in the United States.

As such, the more risk that you took onto your books, especially in the form of periphery sovereign debt, the more likely it was that your risk would be covered by the ECB, your national government, or both. This would be a moral hazard trade on a continental scale. The euro may have been a political project that provided the economic incentive for this kind of trade to take place. But it was private-sector actors who quite deliberately and voluntarily jumped at the opportunity. Now, either because they really believed that the untested ECB had magically removed all risk from the system or saw the possibilities of a moral hazard trade, or both, major European banks took on as much periphery sovereign debt (and other periphery assets) as they could. Indeed, as we shall see below, these banks were incentivized by the European Commission to get their hands on as many periphery bonds as they could and use them as collateral in repo transactions, thereby upping the demand for them still further.52 There was, however, one slight flaw in the plan.


pages: 590 words: 153,208

Wealth and Poverty: A New Edition for the Twenty-First Century by George Gilder

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affirmative action, Albert Einstein, Bernie Madoff, British Empire, capital controls, cleantech, cloud computing, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, deindustrialization, diversified portfolio, Donald Trump, equal pay for equal work, floating exchange rates, full employment, George Gilder, Home mortgage interest deduction, Howard Zinn, income inequality, invisible hand, Jane Jacobs, Jeff Bezos, job automation, job-hopping, Joseph Schumpeter, knowledge economy, labor-force participation, margin call, Mark Zuckerberg, means of production, medical malpractice, minimum wage unemployment, money: store of value / unit of account / medium of exchange, Mont Pelerin Society, moral hazard, mortgage debt, non-fiction novel, North Sea oil, paradox of thrift, Plutocrats, plutocrats, Ponzi scheme, post-industrial society, price stability, Ralph Nader, rent control, Robert Gordon, Ronald Reagan, Silicon Valley, Simon Kuznets, skunkworks, Steve Jobs, The Wealth of Nations by Adam Smith, Thomas L Friedman, upwardly mobile, urban renewal, volatility arbitrage, War on Poverty, women in the workforce, working poor, working-age population, yield curve

In the delicate balance between the risk and insurance features of capitalism, the boundaries are defined by what insurance companies term moral hazard. Moral hazard is the danger that a policy will encourage the behavior—or promote the disasters—that it insures against. This is the limiting point in insurance schemes and it sets the natural boundary of welfare in a capitalist system. Just as a siege of saving, or hoarding of gold, impelled by a fear of economic trouble, may cause depression by greatly reducing consumer demand, so a siege of insurance can bring about some of the dangers that motivate it. Even private insurance firms, under the pressure of government to extend their services, can suffer from a number of serious moral hazards. Arson for some years was among America’s most popular crimes; most of it was induced by fire insurance.

Even these private insurers, who unlike governments are compelled to base their rates and acceptances on sound actuarial principles, face a serious and growing problem of moral hazard, which regulation is making more difficult to remedy. The expansion of private insurance also creates externalities—problems that go beyond the immediate effects of the policy. Millions of citizens are coming to believe that their best chance of striking it rich comes not from work and investment, but from suing the successful; not from health, but from opportune disability; not from extended and productive careers, but from timely retirement. Most fundamentally, people experience a steady erosion of the link between conduct and its consequences, effort and reward, merit and remuneration. The moral hazards of private insurance thus may contribute to the declining productivity of the American economy.

It no longer responds so well to the bad news of scarcity and disequilibrium—the high prices that signal new opportunities—and no longer provides so dependably the good news of creativity, invention, and entrepreneurship. This is the overall moral hazard of the welfare state. But all insurance and welfare programs do not present this problem, and some of them compensate for it by creating an atmosphere of safety more hospitable to long-range ventures and investments. The leaders of capitalism must become more discriminating in appraising the claims and demands, dangers and benefits of the eleemosynary state. It is not an alien presence but the now burly offspring of an essentially capitalist idea. The moral hazards of government programs are clear. Unemployment compensation promotes unemployment.5 Aid to Families with Dependent Children (AFDC) made more families dependent and fatherless.


pages: 363 words: 107,817

Modernising Money: Why Our Monetary System Is Broken and How It Can Be Fixed by Andrew Jackson (economist), Ben Dyson (economist)

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Deposit insurance removes a depositor’s incentive to monitor bank lending decisions because they are guaranteed to receive their money back. This is known as moral hazard.10 Because deposits in different banks are equally ‘risky’ when they are all underwritten by the government, for banks the cost of attracting central bank reserves (via customer deposits) is not affected by whether they are making high-risk or low-risk investments. With all investments via banks effectively risk-free because of government guarantees, the bank that offers the highest interest rate on its deposits will tend to find that funds flow to it from the other banks. This problem is explicitly referred to in a handbook written by the Bank of England’s Centre for Central Banking Studies: “Bank depositors may, therefore, contribute to moral hazard if deposit insurance means that they no longer feel obliged to assess the credit risk associated with depositing money with a particular bank.

Not suffering from the downsides of their investment decisions, banks are more willing to extend credit and borrowers are more willing to invest in assets they believe to be ‘protected’. Furthermore, the implicit insurance the government has provided is likely to lead to an increase in the risky behaviour (due to moral hazard) that led to the crisis in the first place, setting the stage for an even bigger crisis in the future. Conversely, under the reformed system, banks would be allowed to fail. The government and central bank would be under no obligation to intervene in the market and in so doing validate risky behaviour. This will lower moral hazard, as banks will now face the full downside of their investment decisions. This should decrease their willingness to participate in asset price bubbles. As a consequence the tendency for asset price inflation due to risky bank behaviour should be lower.

Due to the failure of certain banks in 2008-09, just £171 million of the £19.86 billion (less than 1%) was funded through levies, while the rest was provided by government (Financial Services Compensation Scheme, 2009). There are two main problems with deposit insurance. The first is that by being insured, customers will take little or no interest in the way that the bank lends and takes risks. This is known as ‘moral hazard’.3 In a system without deposit insurance, depositors would have a strong incentive to monitor their bank’s behaviour to ensure the bank does not act in a manner that may endanger its own solvency. For example, a depositor would be concerned with the types of loans their bank was making and the amount of capital their bank had (capital acts as a buffer, protecting depositors from losses when loans go bad).


pages: 478 words: 126,416

Other People's Money: Masters of the Universe or Servants of the People? by John Kay

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Affordable Care Act / Obamacare, asset-backed security, bank run, banking crisis, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Swan, Bonfire of the Vanities, bonus culture, Bretton Woods, call centre, capital asset pricing model, Capital in the Twenty-First Century by Thomas Piketty, cognitive dissonance, corporate governance, Credit Default Swap, cross-subsidies, dematerialisation, diversification, diversified portfolio, Edward Lloyd's coffeehouse, Elon Musk, Eugene Fama: efficient market hypothesis, eurozone crisis, financial innovation, financial intermediation, fixed income, Flash crash, forward guidance, Fractional reserve banking, full employment, George Akerlof, German hyperinflation, Goldman Sachs: Vampire Squid, Growth in a Time of Debt, income inequality, index fund, inflation targeting, interest rate derivative, interest rate swap, invention of the wheel, Irish property bubble, Isaac Newton, London Whale, Long Term Capital Management, loose coupling, low cost carrier, M-Pesa, market design, millennium bug, mittelstand, moral hazard, mortgage debt, new economy, Nick Leeson, Northern Rock, obamacare, Occupy movement, offshore financial centre, oil shock, passive investing, peer-to-peer lending, performance metric, Peter Thiel, Piper Alpha, Ponzi scheme, price mechanism, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, railway mania, Ralph Waldo Emerson, random walk, regulatory arbitrage, Renaissance Technologies, rent control, Richard Feynman, risk tolerance, road to serfdom, Robert Shiller, Robert Shiller, Ronald Reagan, Schrödinger's Cat, shareholder value, Silicon Valley, Simon Kuznets, South Sea Bubble, sovereign wealth fund, Spread Networks laid a new fibre optics cable between New York and Chicago, Steve Jobs, Steve Wozniak, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Tobin tax, too big to fail, transaction costs, tulip mania, Upton Sinclair, Vanguard fund, Washington Consensus, We are the 99%, Yom Kippur War

‘Too big to fail’ takes responsibility for the supervision of credit risks away from market participants and places it more or less exclusively in the hands of regulators: a duty that in this instance (and many others) they were not capable of discharging. The term ‘moral hazard’ is perhaps unfortunate, because moral hazard is about incentives, not about ethics: about deterrence rather than punishment. Timothy Geithner appeared to have missed this point – his memoir makes frequent reference to moral hazard, almost invariably accompanied by a disparaging reference to ‘Old Testament fundamentalists’.32 Presumably this is with the intention of contrasting the retributive ethos of the Old Testament with the forgiveness found in the New. Many might feel retribution rather than forgiveness appropriate for those responsible for the global financial crisis. But those who worry about moral hazard are not motivated by revenge. Moral hazard in its application to the banking system is the well-founded concern that, if there is an expectation of government assistance for troubled financial businesses, the people who run and trade with these businesses will behave in ways that make the need for such assistance more likely.

Still, the sense that Central Banks and Treasuries act as backstop has influence on the behaviour of a firm: Dick Fuld of Lehman was delusional both about the risks in his business and in his belief that Lehman both should and would receive support if it ran into financial difficulties. If Fuld had not made these errors, he would have made greater efforts to sell Lehman’s business before it collapsed. But the more serious problem of moral hazard is its impact on those who deal with banks. If potential creditors know that they will be made whole, then they have little incentive to undertake careful credit assessment. In the sub-prime mortgage fiasco such moral hazard arose at every level. Fannie Mae and Freddie Mac, the failed US mortgage agencies, could not conceivably have built their enormous, and severely under-capitalised, balance sheets had their lenders not believed (correctly, as it turned out) that their liabilities were guaranteed by the US government.

In Michel Albert’s Swiss village, community pressures handled the problems of information asymmetry, adverse selection and moral hazard. Information asymmetry was reduced, though not necessarily eliminated, by geographical proximity and personal ties. The obligation to participate was informed by the link between economic and social life, and for most it was no obligation at all. Some people were better guardians of their herds than others, some shirked their responsibilities, and others discharged them more than conscientiously, but these differences were ignored in the interests of maintaining a harmonious community. Insurance markets exist for risks that involve a substantial degree of randomness – which reduces the problem of information asymmetry, and where the insured has limited influence over the incidence of risk – which reduces the effect of moral hazard. We can insure against car accidents, against our house burning down, against dying prematurely or against living too long.


pages: 460 words: 122,556

The End of Wall Street by Roger Lowenstein

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Asian financial crisis, asset-backed security, bank run, banking crisis, Berlin Wall, Bernie Madoff, Black Swan, Brownian motion, Carmen Reinhart, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversified portfolio, eurozone crisis, Fall of the Berlin Wall, fear of failure, financial deregulation, fixed income, high net worth, Hyman Minsky, interest rate derivative, invisible hand, Kenneth Rogoff, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, Martin Wolf, moral hazard, mortgage debt, Northern Rock, Ponzi scheme, profit motive, race to the bottom, risk tolerance, Ronald Reagan, savings glut, short selling, sovereign wealth fund, statistical model, the payments system, too big to fail, tulip mania, Y2K

This for a firm that traded at 62 at the start of the week! Paulson had a surprising response: The price should be lower.17 The secretary was hypersensitive to the charge that Washington was helping Bear’s shareholders, cushioning the impact of failure and thus dulling the perceived incentive of other banks to monitor their risks. (In the language of economists, policies that weaken such incentives and encourage excessive risk-taking create a “moral hazard”; it was a charge that had often been leveled at Greenspan.) Morgan settled on $2 a share, prompting howls of protest from Bear. Critically, Morgan agreed to provide a backstop—to guarantee Bear’s trades—so that Bear could remain in business until the deal closed, and the Fed agreed to finance, and absorb any losses on, $29 billion of Bear’s most problematic assets.v Essentially, the taxpayers would cover Jamie Dimon’s downside.

Since profit-motivated bankers were unwilling to lend against deflating collateral, the Fed was doing so itself. 21 Not only had the Fed become the bank to Wall Street, it was willing to take the Street’s paper. To further buoy markets, the Fed cut interest rates. These actions did not, as some argued, entice firms to fail, but they did sustain their ability to take the sort of risks that might lead to failure. In particular, they encouraged lenders to keep lending. The press focused on whether the price paid for Bear’s stock imposed a sufficient penalty on shareholders,w but the real moral hazard was that people who had lent to Bear suffered no pain at all. In fact, they were rewarded. Prior to the acquisition, Bear’s credits traded at a discount. (Its IOU was worth much less than face value, or “par.”) Once its debts became the obligation of JPMorgan, they returned to par. Robert Barbera, a prominent Wall Street economist, naturally counseled clients that they could count on the United States to back up Wall Street credits.22 Thanks to the Fed, the lending could go forth; thus was the illusion of solvency sustained.

Thain could not be budged. In the spring, he even hired two of his former Goldman cronies, guaranteeing them each tens of millions of dollars—evidence anew of the compensation disconnect at a bank losing billions every quarter.30 The regulators that spring were more worried than the bankers. They were torn between their desire for expanded powers and the wish not to seem either overly meddling or insensitive to moral hazard. Geithner insisted in testimony to the Senate that the Fed only lent to “sound institutions,” though that hardly described Bear Stearns.31 But he, like Paulson and Bernanke, were concerned that their scope was too limited. The system should not be so fragile as to depend on ad hoc, extralegal improvisation. The Treasury and Fed were still worried about the remaining investment banks, in particular Lehman.


pages: 320 words: 97,509

Doctored: The Disillusionment of an American Physician by Sandeep Jauhar

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Affordable Care Act / Obamacare, delayed gratification, illegal immigration, income inequality, medical malpractice, moral hazard, obamacare, profit motive, randomized controlled trial, stem cell, The Wealth of Nations by Adam Smith, Yogi Berra

In 1867 the Aetna Guide to Fire Insurance introduced the concept of moral hazard into actuarial science. The publication warned that generous insurance policies could make some people careless about preventing fires. Protected in part from the consequences of their actions, those people were more likely to engage in risky behavior, like not clearing their yards of brush or leaving their houses without adequate ventilation. The guide made a revolutionary and counterintuitive point: insurance in some cases can increase risk. Moral hazard undoubtedly plays a role in health care, too. When people complain that their rising insurance premiums are funding others’ irresponsible behavior, they are complaining about moral hazard. When patients with low-deductibility insurance go to the emergency room for a hangnail, they are succumbing to moral hazard. When a nurse in the ICU criticizes a family for refusing to authorize a DNR order (“They would never do this if they had to pay for it”), she is talking about moral hazard.

When a nurse in the ICU criticizes a family for refusing to authorize a DNR order (“They would never do this if they had to pay for it”), she is talking about moral hazard. The moral hazard hypothesis was put to the test in the 1970s with the RAND Health Insurance Experiment. For a decade it followed eight thousand people who had been randomly assigned to one of five types of health insurance plan: an HMO-style group cooperative or a traditional plan that covered 100 percent, 95 percent, 50 percent, or 25 percent of costs. Predictably, the study found that medical spending was highest when 100 percent of costs were covered. If health care is perceived as free, patients will demand more of it. Moral hazard is at play on the provider side, too. Chest pains? Why not order a stress test when the nuclear camera is in the next room.

Of course, many forces, including new and expensive technology, the aging of the population, and the rise of chronic diseases, are behind increasing imaging costs. But moral hazard undoubtedly plays a role. Managed care, with its reliance on high deductibles and capitation, in which physicians are paid a set amount per assigned patient, whether or not that patient seeks care, came of age with the idea of controlling moral hazard. In the 1970s many insurers adopted co-payments to increase the price of medical care to consumers in an effort to reduce inefficient spending. In the 1980s and 1990s, economists promoted fixed payments and utilization review, in which payers approve or deny requests for medical services, to further reduce moral hazard. The managed care system that we know today is largely a product of this theory. And though it worked for a while—health expenditures slowed significantly in the 1980s and 1990s, the heyday of managed care—patient and physician revulsion against third-party interference in medical decision-making eventually forced many insurers to back away from these unpopular cost-cutting strategies.


pages: 357 words: 110,017

Money: The Unauthorized Biography by Felix Martin

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bank run, banking crisis, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, Bretton Woods, British Empire, call centre, capital asset pricing model, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, credit crunch, David Graeber, en.wikipedia.org, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, Fractional reserve banking, full employment, Goldman Sachs: Vampire Squid, Hyman Minsky, inflation targeting, invention of writing, invisible hand, Irish bank strikes, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, mobile money, moral hazard, mortgage debt, new economy, Northern Rock, Occupy movement, Plutocrats, plutocrats, private military company, Republic of Letters, Richard Feynman, Richard Feynman, Robert Shiller, Robert Shiller, Scientific racism, seigniorage, Silicon Valley, smart transportation, South Sea Bubble, supply-chain management, The Wealth of Nations by Adam Smith, too big to fail

Those who doubted the wisdom of all this were dismissed as economic Luddites—until the pyramid of credit developed the odd crack when interest rates spiked and a few of the smaller firms went under. Then came rumours that a really big fish was in trouble. It seemed inconceivable that the regulators would let it go: everyone knew that it was “too big to fail.” Yet the sanctimonious talk of the dangers of moral hazard emanating from the central bank was far from reassuring. And then, taking everyone by surprise, it happened. There was a full-blown run, and the central bank let it fail. All hell broke loose: a panic the like of which hadn’t been seen for decades. As financial markets tanked, credit seized up, and the economy capsized, moral hazard was suddenly the last thing the central bankers were worrying about. The policy-makers realised that the time had come to run the printing press at full tilt and bail out the financial sector before it disintegrated completely.

“Financial stability,” warned Daniel Tarullo—the leading authority on bank regulation on the Board of Governors of the Federal Reserve—in June 2012, “is, in important ways, endogenous to the financial system, or at least the kind of financial system that has developed in recent decades.”10 Moral hazard is hard-wired into the system. This is why attempting to mitigate it by tinkering with capital ratios or liquidity requirements would be a Sisyphean task. So long as the nature of banking is to lend long-term by borrowing short-term, and take credit risk whilst promising none, the boulder of moral hazard would forever be tumbling back to the bottom of the hill just as the regulators think they have it fixed. What is needed is reform targeted at the fundamental structure of the banking system, rather than at the behaviour of the bankers within it.

Those praying for a merciful policy from Trevelyan’s Treasury should, however, have been forewarned by the very first sentence of an editorial shot across his bows from The Economist magazine in late November 1845. It opened with a chilling warning: “[c]harity is the national error of Englishmen.”9 There was no question that the impending Irish famine was an economic disaster and a human tragedy. But simply sending aid was absolutely the wrong way to help. It would violate two central principles of economic theory. The first was the need to avoid moral hazard. Send aid, and one might alleviate the immediate problem—but at the cost of reducing the Irish to a state of permanent dependency. The second was the hallowed principle of non-intervention in the operation of the market. Adam Smith had proved that it was allowing private self-interest to operate as freely as possible that most efficiently achieves the social good. For the government to interfere with the operation of the market in solving the crisis would therefore be a foolish error.


pages: 545 words: 137,789

How Markets Fail: The Logic of Economic Calamities by John Cassidy

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Albert Einstein, Andrei Shleifer, anti-communist, asset allocation, asset-backed security, availability heuristic, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Black-Scholes formula, Bretton Woods, British Empire, capital asset pricing model, centralized clearinghouse, collateralized debt obligation, Columbine, conceptual framework, Corn Laws, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Daniel Kahneman / Amos Tversky, debt deflation, diversification, Elliott wave, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, George Akerlof, global supply chain, Haight Ashbury, hiring and firing, Hyman Minsky, income per capita, incomplete markets, index fund, invisible hand, John Nash: game theory, John von Neumann, Joseph Schumpeter, laissez-faire capitalism, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, market clearing, mental accounting, Mikhail Gorbachev, Mont Pelerin Society, moral hazard, mortgage debt, Naomi Klein, Network effects, Nick Leeson, Northern Rock, paradox of thrift, Ponzi scheme, price discrimination, price stability, principal–agent problem, profit maximization, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, RAND corporation, random walk, Renaissance Technologies, rent control, Richard Thaler, risk tolerance, risk-adjusted returns, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, technology bubble, The Chicago School, The Great Moderation, The Market for Lemons, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, unorthodox policies, value at risk, Vanguard fund

“Insurance removes the incentive on the part of individuals, patients, and physicians to shop around for better prices for hospitalization and surgical care,” Arrow noted. Following Arrow’s example, economists now refer to the phenomenon of insurance changing people’s behavior as “moral hazard.” Ultimately, this is another problem of hidden information: insurers can’t fully monitor the behavior of their policyholders, so they try to influence it in other ways. In the cases of hurricane and earthquake insurance, moral hazard is a minor concern, because the policyholders can’t affect the probability of a payout. In other areas, they can. Motorists with car insurance tend to drive less carefully and leave their vehicles unattended, which means they are more likely to crash and have their vehicle stolen; drivers with seat belts tend to drive faster; and property owners with fire insurance are less apt to install fire alarms and fire extinguishers.

But such measures add to the insurers’ already substantial administrative costs, and they haven’t proved sufficient to keep down costs. One way to banish moral hazard would be to do away with health insurance, but that would also eliminate the benefits of risk sharing, which are substantial. Alternatively, insurers could refuse to pay for superfluous tests and treatments that don’t offer much prospect of curing the patient. In a competitive environment, however, holding the line is difficult. For any individual insurer, there is always a temptation to offer more services in order to attract more customers. Arrow and many other economists who have studied the health care industry believe that the only effective way to control escalating medical costs is to move to a single-payer system, where the government could address the problem of moral hazard by imposing some limits on the consumption of medical services.

That information would be hidden from you. The second problem is moral hazard. Let’s say one of the entrepreneurs’ schemes struck you as safe and sound, and you lent him the $100,000 to pursue it. Once he had taken your money, how could you prevent him from investing it in a much riskier venture that might make him rich but would also make him more likely to default on the loan? With great difficulty, is the answer. By far the wiser course of action is to put your money in a CD, accept a slightly lower rate of return, and let the bank handle the information problem: after all, that is what it is there for. By cultivating long-term lending relationships with businesses, banks are able to mitigate the lemons issue and moral hazard. A properly run bank doesn’t extend a loan before it examines the borrower’s credit history and convinces itself of the soundness of his or her business plan.


pages: 288 words: 16,556

Finance and the Good Society by Robert J. Shiller

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bank run, banking crisis, barriers to entry, Bernie Madoff, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, cognitive dissonance, collateralized debt obligation, collective bargaining, computer age, corporate governance, Daniel Kahneman / Amos Tversky, Deng Xiaoping, diversification, diversified portfolio, Donald Trump, Edward Glaeser, eurozone crisis, experimental economics, financial innovation, full employment, fundamental attribution error, George Akerlof, income inequality, invisible hand, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, land reform, loss aversion, Louis Bachelier, Mahatma Gandhi, Mark Zuckerberg, market bubble, market design, means of production, microcredit, moral hazard, mortgage debt, Occupy movement, passive investing, Ponzi scheme, prediction markets, profit maximization, quantitative easing, random walk, regulatory arbitrage, Richard Thaler, road to serfdom, Robert Shiller, Robert Shiller, Ronald Reagan, self-driving car, shareholder value, Sharpe ratio, short selling, Simon Kuznets, Skype, Steven Pinker, telemarketer, The Market for Lemons, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, Vanguard fund, young professional, Zipcar

This is why the Squam Lake Group (a nonpartisan, nona liated group of fteen academics who o er counsel on nancial regulation, of which I am a member) advised in its 2009 report that the government should not regulate t h e level of CEO compensation. Some CEOs are, and always will be, worth a great deal to their rms. On the other hand, the group did believe that regulation of the structure of CEO compensation is called for.5 Moral Hazard and Deferred Compensation There is a reason for the government to intervene in the process of determining executive salaries: to mitigate a speci c moral hazard that seems to have played a substantial role in causing the nancial crisis that began in 2007—at least for big and so-called systemically important rms. This moral hazard arises because the CEOs and other top o cers of such key rms have incentives to take extraordinary risks. They believe that their companies are too big to be allowed to fail. Because the failure of their companies would be simply too disruptive to the economy as a whole, they reason that the government will not allow that to happen.

Hence banking plays an even bigger role in the economies of less-developed countries.5 In contrast, the role of traditional banks in the economies of more advanced countries has been in decline for decades: the fraction of these countries’ debt that is accounted for by traditional bank loans has been falling.6 This is so because the quality of publicly available information about securities is improving, and so the moral hazard and selection bias problems are reduced. Banks will increasingly be transformed into more complex institutions, but their traditional banking business will not go away entirely. Such banking meets too many of society’s needs, and banks’ public persona—current events notwithstanding—is too strong. The Evolution and Future of Banking Indeed the severe nancial crisis that began in 2007 was not due to any failures in the traditional banking business model, but instead to certain new kinds of business models, in which loans made to homeowners were not retained on the books of banks and other mortgage originators but bundled together into securities and sold o to other investors, including other banks—reintroducing the very problem of moral hazard that banks were supposed to solve.

But somehow it is thought that bankers must know what they are doing. This distinction must in part have to do with the fact that bankers typically stay out of the most volatile, headline-grabbing markets. But perhaps too it is because bankers, in contrast to hedge fund managers and the like, are following a long and time-honored tradition, extending back hundreds of years, which has evolved to solve certain problems—including liquidity, moral hazard and selection bias, and transaction service problems—to the satisfaction of most people most of the time. The anger toward bankers takes a very di erent form. It seems to be anger at their power and presumption, at their single-minded pursuit of money. And the anger ares up whenever there is a banking crisis and the governments of the world come to the rescue of these wealthy interests. But the public also has a sense of the centrality, sobriety, and safety of banks, and they must know that those who manage banks are highly in uential in determining the economic outcomes in our society.

Culture and Prosperity: The Truth About Markets - Why Some Nations Are Rich but Most Remain Poor by John Kay

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Albert Einstein, Asian financial crisis, Barry Marshall: ulcers, Berlin Wall, Big bang: deregulation of the City of London, California gold rush, complexity theory, computer age, constrained optimization, corporate governance, corporate social responsibility, correlation does not imply causation, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, Donald Trump, double entry bookkeeping, double helix, Edward Lloyd's coffeehouse, equity premium, Ernest Rutherford, European colonialism, experimental economics, Exxon Valdez, failed state, financial innovation, Francis Fukuyama: the end of history, George Akerlof, George Gilder, greed is good, haute couture, illegal immigration, income inequality, invention of the telephone, invention of the wheel, invisible hand, John Nash: game theory, John von Neumann, Kevin Kelly, knowledge economy, labour market flexibility, late capitalism, Long Term Capital Management, loss aversion, Mahatma Gandhi, market bubble, market clearing, market fundamentalism, means of production, Menlo Park, Mikhail Gorbachev, money: store of value / unit of account / medium of exchange, moral hazard, Naomi Klein, Nash equilibrium, new economy, oil shale / tar sands, oil shock, pets.com, popular electronics, price discrimination, price mechanism, prisoner's dilemma, profit maximization, purchasing power parity, QWERTY keyboard, Ralph Nader, RAND corporation, random walk, rent-seeking, risk tolerance, road to serfdom, Ronald Coase, Ronald Reagan, second-price auction, shareholder value, Silicon Valley, Simon Kuznets, South Sea Bubble, Steve Jobs, telemarketer, The Chicago School, The Death and Life of Great American Cities, The Market for Lemons, The Nature of the Firm, The Predators' Ball, The Wealth of Nations by Adam Smith, Thorstein Veblen, total factor productivity, transaction costs, tulip mania, urban decay, Washington Consensus, women in the workforce, yield curve, yield management

The only solution to the potential information asymmetry is to stop such information being collected at all-which would be impossible even if it were desirable. In fifty years, private medical and life insurance may { 240} John Kay be as difficult to obtain as divorce and unemployment insurance today, and for the same reasons. Moral Hazard Most risks in our environment depend on the actions we take. If we have financial protection against risk, we will expose ourselves to more risks. This is the problem of moral hazard. 12 People do not allow their houses to burn down because they have fire insurance. Young women do not set out to become pregnant because there are social benefits for single mothers. But their behavior is adaptive. Social habits and economic institutions evolve together. With no fire insurance, there would be fewer chip pans and open fires.

Roads have become more dangerous, but precautions by children and their parents have more than offset the dangers of heavy traffic. 14 Moral hazard makes it dangerous to insure risks that are under the control of the insured. In 1982, Congress deregulated savings and loans associations. 15 But it maintained a system of insurance for their depositors. The combination proved irresistible to fools and crooks. 16 The government met losses that ultimately ran to the tens of billions of dollars while the savings and loans, and their execu- Culture and Prosperity { 241} tives, kept the gains. When those you insure can influence the risks you cover, you must supervise them. Social Insurance of Personal Risks ••••••••••••••••••••••••••••••••••••• When people can opt out, adverse selection is a problem. If you can't easily watch what they're doing, moral hazard is a problem. The combination of adverse selection and moral hazard means that risks are best managed by groups that have other common bonds: typically families, communities, workplaces, and nations.

The term social insurance originated in Germany in the late nineteenth century, 18 as government came to take over the insurance functions of voluntary organizations such as mutual societies and trade unions and to extend more generally the kinds ofbenefit they had provided to employees. This organized mutual sharing of risks is today part of the economic structure of most West European states. Government is well-placed to reduce adverse selection, because it can compel participation, but is less effective at reducing moral hazard than the social pressures of a local community. Formal social insurance schemes address the moral hazard problem by limiting the generosity of the benefits they provide, the time period for which the benefits are paid, and attaching conditions-such as tests of genuineness of the search for work-to their benefits. Business Risk Some economic risks are inescapable. The risk that crops will fail. Uncertainty about the growth in demand for mobile phones.


pages: 389 words: 98,487

The Undercover Economist: Exposing Why the Rich Are Rich, the Poor Are Poor, and Why You Can Never Buy a Decent Used Car by Tim Harford

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Albert Einstein, barriers to entry, Berlin Wall, collective bargaining, congestion charging, Corn Laws, David Ricardo: comparative advantage, decarbonisation, Deng Xiaoping, Fall of the Berlin Wall, George Akerlof, invention of movable type, John Nash: game theory, John von Neumann, market design, Martin Wolf, moral hazard, new economy, price discrimination, Productivity paradox, race to the bottom, random walk, rent-seeking, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, sealed-bid auction, second-price auction, second-price sealed-bid, Shenzhen was a fishing village, special economic zone, spectrum auction, The Market for Lemons, Thomas Malthus, trade liberalization, Vickrey auction

While it is impossible for insurance companies (or anyone else) • 123 • T H E U N D E R C O V E R E C O N O M I S T to avoid moral hazard altogether, they can take steps to reduce it. For example, they do not offer insurance against being fired or becoming pregnant, which is a shame, because it would be great to have that kind of insurance. The reason is easy to see: it is easy to arrange to be fired or to get pregnant. There are many people who would like to leave their jobs and many others who would like to have children, and such people would be particularly eager to buy an insurance policy that would pay them handsomely for putting their plans into action. As a result, moral hazard destroys the market for private unemployment insurance. On the other hand, public unemployment insurance still exists, in spite of moral hazard. It is not polite to say so, but it is obvious that paying people to be unemployed encourages unemployment.

Imperfect information— the whole story The lemons problem (“adverse selection” in the economists’ jargon), when inside information guts a market because ignorant buyers are unwilling to pay for quality they cannot observe, is one example of the broader problem of inside information (“asymmetric information” in the jargon). Inside information also produces an obstacle called “moral hazard.” The concept is simple: if you compensate people when bad things happen to them, they may get careless. If my car is insured against theft, I will park wherever I find a space, even on a deserted street that doesn’t seem entirely safe. If my insurance doesn’t cover theft I may choose to pay a little extra to park in a lot with an attendant. If I lose my job and the government pays unemployment benefit, I may not hurry to find a new job quite as quickly as I would if I had no income whatso-ever. If the money in my checking account is insured against a bank failure, why bother to check that the bank is financially sound? Moral hazard is an inevitable problem in the real economy. While it is impossible for insurance companies (or anyone else) • 123 • T H E U N D E R C O V E R E C O N O M I S T to avoid moral hazard altogether, they can take steps to reduce it.

The truth is that we have a trade-off: it is bad to encourage unemployment but good to support those without incomes. Both governments and private insurers will try to protect themselves against moral hazard. One of the most common ways insurance companies do this is by modifying the insurance policy to provide incomplete insurance, in the form of a deductible. If my car insurance deductible is $200, the fear of losing that money probably won’t persuade me to take extravagant safety precautions, but it should be enough to make me check that my car is locked. Another way insurance companies can fight moral hazard is by gaining access to the inside information. Health insurers will want to know whether I am a smoker before they set my premiums. Of course, I could lie, but it wouldn’t be too hard for insurers to expose my lie; a simple medical examination would reveal that I smoke.


pages: 335 words: 82,528

A Theory of the Drone by Gregoire Chamayou

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failed state, Francis Fukuyama: the end of history, moral hazard, Necker cube, private military company, RAND corporation, telepresence, V2 rocket, Yom Kippur War

It is claimed that drone use is justified because it would create fewer collateral victims than other weapons that could have been used in its place. What this argument postulates is that those other means really would have been used—in other words, that the military action would have taken place anyway, and it’s just a question of which weapon is used. But that is precisely what the moral hazard associated with drones renders doubtful. The sophistry becomes clear when one reflects that those other means might never have been employed because of the prohibitively high reputational costs associated with them. Another way of putting that is to say that in a situation of moral hazard, military action is very likely to be deemed “necessary” simply because it is possible, and possible at a lower cost.10 In such cases, it is necessarily false to say that the drone has inflicted less collateral damage: as Jeremy Hammond sums up, the number of civilian victims “of course isn’t lower than it would be if there weren’t drone strikes, in which case precisely zero civilians would be killed in them.”11 The second objection concerns the cumulativeness of lesser evils.

As John Kaag and Sarah Kreps write, given that “remote-controlled machines cannot suffer the consequences [of their actions] and the humans who operate them do so at a great distance, the myth of Gyges is more a parable of modern counterterrorism than it is about terrorism.”1 Freed from the constraints imposed by reciprocal relations, will the drone masters be able to continue to demonstrate virtue and to resist the temptation to commit injustice with virtually no sanction imposed? That question, to which we shall return, raises the matter of moral hazard. But there is another way of posing the problem. If it remains true that “the strongest is never strong enough to be always the master, unless he transforms his strength” into virtue,2 we may ask ourselves the following question: what kind of right or virtue is needed by these modern Gyges? Let us put that question another way: not whether the invisible man can be virtuous, but what redefinition of virtue will he need if he wishes to persist in calling himself virtuous and considering himself to be so even in his own eyes.

In a totally coherent fashion, we today find modernized versions of a Hobson-type anti-imperialist argument in the works of a whole series of writers who set out to criticize the drones from a liberal point of view, using the tools of the economic decision-making theory. Assuming that the democratic commander in chief is a rational agent, how will the “low cost” of this weapon affect his decisions? The main effect is to introduce a massive bias into his decision. Any agent who can take action with fewer risks to himself or his camp is likely to adopt a riskier pattern of behavior—that is to say, riskier for others. Similarly, the drone is a classic “moral hazard”—a situation in which being able to act without bearing the costs of the consequences relieves agents of responsibility for their decisions.8 More precisely, we are told that drones introduce a threefold reduction in the costs traditionally attached to the use of armed force: a reduction of the political costs associated with the loss of national lives, a reduction of the economic costs associated with armament, and a reduction of the ethical or reputational costs associated with the perceived effects of the violence that is committed.9 That last point is very important.


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How the Other Half Banks: Exclusion, Exploitation, and the Threat to Democracy by Mehrsa Baradaran

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access to a mobile phone, affirmative action, asset-backed security, bank run, banking crisis, banks create money, barriers to entry, British Empire, call centre, Capital in the Twenty-First Century by Thomas Piketty, cashless society, credit crunch, David Graeber, disintermediation, diversification, failed state, fiat currency, financial innovation, financial intermediation, Goldman Sachs: Vampire Squid, housing crisis, income inequality, Internet Archive, invisible hand, Kickstarter, M-Pesa, McMansion, microcredit, mobile money, moral hazard, mortgage debt, new economy, Own Your Own Home, payday loans, peer-to-peer lending, price discrimination, profit maximization, profit motive, quantitative easing, race to the bottom, rent-seeking, Ronald Reagan, Ronald Reagan: Tear down this wall, savings glut, the built environment, the payments system, too big to fail, trade route, transaction costs, unbanked and underbanked, underbanked, union organizing, white flight, working poor

In other words, FDIC insurance was only a “subsidy” if it was underpriced, and therefore, it was possible to find an accurate market price for this government support. The philosophy also relied on “market discipline” to supplant regulatory controls. The argument was that banks would not be incentivized to take risks because if they did, the market would punish them, and the FDIC would facilitate their failure, thus eliminating any concerns about moral hazard. Obviously, this was not the case twenty years later when government bailouts abruptly cut off market discipline. In fact, market discipline for banks, if it exists at all, is not robust because of the moral hazard introduced by deposit insurance. And what of the fears of concentrated power that so consumed Jefferson, Brandeis, and Roosevelt? The FDIC was not too worried: “There will [not] be fewer banks or less competition in any given market.… While concentrations of political power may be undesirable, it is not clear that large organizations or highly concentrated industries are able to wield too much influence over government.

By offering the scared public a safe haven, this simple government protection would help stop panic in its tracks. And so, postal banking’s popularity increased. Many saw it as a way to respond to the constant banking crises of the time and further, viewed it to be a better alternative than federal deposit insurance because there was less moral hazard involved (insurance protection tends to make banks take more risks). The government would fund and oversee postal banks to minimize the chance of moral hazard. And interestingly, it was the Republicans who supported a broad federal banking system rather than a private bank-funded insurance scheme. During the 1908 presidential election, postal banking became a major issue. Fresh in the wake of a financial crisis, the two candidates, Republican William Howard Taft and Democrat William Jennings Bryan, chose different reform proposals.

But because you deposit your money into a bank account insured by the federal government, you feel no need to keep a watchful eye on what your bank does with the money. Insurance removes the incentive for customers to police a bank. It can also remove the incentive for banks to police themselves because they do not bear the full or even the most serious consequences of their actions. Removing the natural tendencies of the market to notice and punish bad choices creates a moral hazard that may result in well-funded cats and other undetected market risks. In the United States, only federal deposit insurance has been effective at stabilizing banks. State and private insurance funds have been attempted and have failed because to be effective at deterring runs, an insurance system must be basically unlimited. If you suspected that because of a limited insurance pool, only ninety of a bank’s one hundred customers would get their deposits back in the event of a bank failure, you would run to the bank to make sure you were among the ninety.


pages: 432 words: 127,985

The Best Way to Rob a Bank Is to Own One: How Corporate Executives and Politicians Looted the S&L Industry by William K. Black

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accounting loophole / creative accounting, affirmative action, Andrei Shleifer, business climate, cognitive dissonance, corporate governance, Donald Trump, fear of failure, financial deregulation, friendly fire, George Akerlof, hiring and firing, margin call, market bubble, moral hazard, offshore financial centre, Ponzi scheme, race to the bottom, Ronald Reagan, short selling, The Market for Lemons, transaction costs

They concentrate in the particular industries that foster the best criminogenic environments. They also concentrate in investments best suited for accounting fraud. That triple concentration means that waves of control fraud will create, inflate, and extend bubbles. MORAL HAZARD Moral hazard is the temptation to seek gain by engaging in abusive, destructive behavior, either fraud or excessive risk taking. Failing firms expose their owners to moral hazard. This is not unique to S&Ls; it is in the nature of corporations. Moral hazard arises when gains and losses are asymmetrical. A company with $100 million in assets and $101 million in liabilities is insolvent. If it is liquidated (sells its assets), the stockholders will get nothing because they are paid only after all the creditors are paid in full.

If the corporation makes an extremely risky investment and it fails, the loss is borne entirely by the creditors. If the investment is a spectacular success, the gain goes overwhelmingly to the shareholders. The shareholders have a perverse incentive to take unduly large risks rather than to make the most productive investments. The examples of moral hazard I have used involve unduly risky behavior. The theory, however, is not limited to honest risk taking. Moral hazard theory also explains why failing firms have an incentive to engage in reactive control fraud (White 1991, 41). Indeed, since S&L control fraud was a sure thing (it was certain to produce, for a time, record profits), reactive control fraud was a better option than an ultra-high-risk gamble. WHY THE S&L INDUSTRY SUFFERED A WAVE OF CONTROL FRAUD Bad regulation exposed the S&L industry to systemic interest-rate risk and caused the first phase of the debacle.

Instead, it endorsed absurd accounting abuses like “loan loss deferral” (which meant not recognizing losses currently) as purportedly superior accounting treatments under economic and accounting theory.6 The task force also encouraged fast growth and interest-rate risk in a get-rich-quick scheme called “risk-controlled arbitrage” (RCA).7 Second, the design and implementation of the cover-up guaranteed a disaster. Moral hazard theory unambiguously predicts that if you greatly weaken restraints on abuse at a time of mass, intense moral hazard, you will suffer severe abuses. Had you asked Richard Pratt, when he was still a graduate student, to write a paper on the effect of removing restraints at a time of mass insolvency, I am confident that you would have received a sound analysis predicting disaster. Moreover, you didn’t need a PhD in economics to figure any of this out.


pages: 632 words: 159,454

War and Gold: A Five-Hundred-Year History of Empires, Adventures, and Debt by Kwasi Kwarteng

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accounting loophole / creative accounting, anti-communist, Asian financial crisis, asset-backed security, Atahualpa, balance sheet recession, bank run, banking crisis, Big bang: deregulation of the City of London, Bretton Woods, British Empire, California gold rush, capital controls, Carmen Reinhart, central bank independence, centre right, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, currency manipulation / currency intervention, Deng Xiaoping, discovery of the americas, Etonian, eurozone crisis, fiat currency, financial innovation, floating exchange rates, Francisco Pizarro, full employment, German hyperinflation, hiring and firing, income inequality, invisible hand, Isaac Newton, John Maynard Keynes: Economic Possibilities for our Grandchildren, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, market bubble, money: store of value / unit of account / medium of exchange, moral hazard, new economy, oil shock, Plutocrats, plutocrats, Ponzi scheme, price mechanism, quantitative easing, rolodex, Ronald Reagan, South Sea Bubble, the market place, The Wealth of Nations by Adam Smith, too big to fail, War on Poverty, Yom Kippur War

Some of the fears which Issing expressed about monetary union were articulated before the euro was born. In his later work on the euro, Issing summarized the problem of ‘moral hazard’ which the euro created. ‘Moral hazard’ is a term in economics which has been defined as the ‘presence of incentives for individuals or institutions to act in ways that incur costs they do not have to bear’.39 One common instance of moral hazard exists in the case of insurance. Economists have observed that possessions which are insured are less well looked after than those without insurance. In 2008, just before the Greek sovereign-debt crisis, Issing wrote that the nations of the eurozone were conducting their fiscal policy under the condition of moral hazard. He wrote: ‘In a single currency area, the political benefit from deficit spending (gaining votes) is enjoyed by national [italics in original] players, while the potential negative effects in the form of higher interest rates (due to increased government borrowing) are felt by all [italics in original] member states.’

As the property market bubble started sharply to deflate, ‘Bear Stearns and Lehman Brothers were the smallest of the big investment banks and the most heavily exposed to the housing market.’22 Other banks, knowing the exposure of these two, became ‘reluctant to provide the short-term funding’ that the pair needed. Bear Stearns was an equally aggressive firm which had collapsed in March 2008. Lehman’s demise had wider repercussions, the reverberations of which were felt, and argued about, for years. Lehman’s problems raised the issue of moral hazard, which has already been referred to in connection with problems associated with the creation of the euro. It was decided, as Lehman tottered and eventually fell, not to ‘bail out’ the bank in order not to create moral hazard. ‘The idea that borrowers should be allowed to escape is one example of “moral hazard”,’ wrote Philip Coggan. ‘Let the borrowers believe they will be rescued from their folly . . . and they will never meet their responsibilities.’ It was this sentiment which prevented US officials from rescuing Lehman Brothers, a decision which, arguably, led to the near-collapse of the global financial system.

He wrote: ‘In a single currency area, the political benefit from deficit spending (gaining votes) is enjoyed by national [italics in original] players, while the potential negative effects in the form of higher interest rates (due to increased government borrowing) are felt by all [italics in original] member states.’ This state of affairs ensured that ‘the resistance to deficit spending is reduced, and the propensity to pursue an (inappropriate) expansionary fiscal policy increases – a typical case of what is known as moral hazard [italics in original]’.40 Observations similar to those made by Issing in 2008 were made by Germans sceptical about the single-currency euro project at the very beginning of the 1990s. Indeed the scale of initial German distrust of the single currency is something which is often overlooked as the German economy came to be regarded as the anchor of the eurozone, and the German political elite began to see themselves as guardians and guarantors of the euro.


pages: 430 words: 109,064

13 Bankers: The Wall Street Takeover and the Next Financial Meltdown by Simon Johnson, James Kwak

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Andrei Shleifer, Asian financial crisis, asset-backed security, bank run, banking crisis, Bernie Madoff, Bonfire of the Vanities, bonus culture, capital controls, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Edward Glaeser, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, financial intermediation, financial repression, fixed income, George Akerlof, Gordon Gekko, greed is good, Home mortgage interest deduction, Hyman Minsky, income per capita, interest rate derivative, interest rate swap, Kenneth Rogoff, laissez-faire capitalism, late fees, Long Term Capital Management, market bubble, market fundamentalism, Martin Wolf, moral hazard, mortgage tax deduction, Ponzi scheme, price stability, profit maximization, race to the bottom, regulatory arbitrage, rent-seeking, Robert Shiller, Robert Shiller, Ronald Reagan, Saturday Night Live, sovereign wealth fund, The Myth of the Rational Market, too big to fail, transaction costs, value at risk, yield curve

Figure 6-1 shows the perceived likelihood that major banks would go bankrupt, as measured by the price of credit default swap protection on their debt; each time the government intervened, the market’s fears ebbed, until finally the stress tests broke the year-long fever. That was what Wall Street needed to hear: they could go back to doing business as usual, and Washington would be there if things went wrong. A panic that began with an attempt to reduce moral hazard by letting Lehman fail only ended when everyone was convinced that the government would not let another major bank fail—magnifying moral hazard to an unprecedented degree. And as the real economy began to bottom out over the summer, it became easier and easier to make money again. But this was only true for the major banks; in the real economy, it became harder and harder to get a loan. According to the Federal Reserve’s survey of bank loan officers, every type of loan became harder to get in every quarter of 2008 and through the first three quarters of 2009.43 In short, Paulson, Bernanke, Geithner, and Summers chose the blank check option, over and over again.

Support by the Federal Reserve can take two broad forms: liquidity loans, where the Fed gives a bank a short-term loan that can be rolled over repeatedly; and lower interest rates, which help banks by promoting economic growth and increasing the chances that bank loans will be paid back.* These steps can mitigate individual disasters. However, the existence of government insurance against a worst-case scenario creates “moral hazard”—the incentive for banks to take on more risk in order to maximize shareholder returns—thereby laying the groundwork for the next system-wide crisis. Each emergency rescue only increases banks’ confidence that they will be rescued in the future, creating a cycle of repeated booms, busts, and bailouts.72 In principle, in exchange for providing this insurance, the Federal Reserve would supervise the banks it was protecting, preventing them from taking too much risk.

As Figure 1-1 demonstrates, the half-century following the Glass-Steagall Act saw by far the fewest bank failures in American history.103 But once financial deregulation began in the 1970s, these low equity levels became increasingly dangerous.104 Figure 1-1: Bank Suspensions and Failures Per Year, 1864—Present * Actual values for 1930-33 are 1,352, 2,294, 1,456, and 4,004. Source: David Moss, “An Ounce of Prevention: Financial Regulation, Moral Hazard, and the End of ‘Too Big to Fail,’” Harvard Magazine, September–October 2009. Used with the permission of Mr. Moss. Updated with data from FDIC, “Failures and Assistance Transactions.” Some of the regulations in place during this period may have been excessive. For example, it’s not clear that limiting banks to a single state—a long-standing rule in the United States that was reaffirmed in the 1930s—makes them safer (other than by restricting competition, which increases their profits).


pages: 355 words: 92,571

Capitalism: Money, Morals and Markets by John Plender

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Andrei Shleifer, asset-backed security, bank run, Berlin Wall, Big bang: deregulation of the City of London, Black Swan, bonus culture, Bretton Woods, business climate, Capital in the Twenty-First Century by Thomas Piketty, central bank independence, collapse of Lehman Brothers, collective bargaining, computer age, Corn Laws, corporate governance, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, discovery of the americas, diversification, Eugene Fama: efficient market hypothesis, eurozone crisis, failed state, Fall of the Berlin Wall, fiat currency, financial innovation, financial intermediation, Fractional reserve banking, full employment, Gordon Gekko, greed is good, Hyman Minsky, income inequality, inflation targeting, invention of the wheel, invisible hand, Isaac Newton, James Watt: steam engine, Johann Wolfgang von Goethe, John Maynard Keynes: Economic Possibilities for our Grandchildren, joint-stock company, Joseph Schumpeter, labour market flexibility, London Interbank Offered Rate, London Whale, Long Term Capital Management, manufacturing employment, Mark Zuckerberg, market bubble, market fundamentalism, means of production, Menlo Park, moral hazard, moveable type in China, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, paradox of thrift, Plutocrats, plutocrats, price stability, principal–agent problem, profit motive, quantitative easing, railway mania, regulatory arbitrage, Richard Thaler, rising living standards, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, shareholder value, short selling, Silicon Valley, South Sea Bubble, spice trade, Steve Jobs, technology bubble, The Chicago School, The Great Moderation, the map is not the territory, The Wealth of Nations by Adam Smith, Thorstein Veblen, time value of money, too big to fail, tulip mania, Upton Sinclair, We are the 99%, Wolfgang Streeck

Historically, the central banks have had a vital role in addressing the confidence trick problem and preventing financial crashes. Long before they acquired their monetary policy role – tightening and relaxing monetary conditions by, for example, raising or reducing interest rates – they acted as lenders of last resort to solvent banks that might otherwise have failed as a result of a contagious financial panic. Given the moral hazard arising from the reduction of market discipline implicit in last-resort lending and the similar moral hazard arising from the introduction of deposit insurance from the 1930s onwards, the central banks also acquired a role in regulating and supervising banks. Yet when Alan Greenspan was chairman of the Federal Reserve as the housing bubble inflated, he conspicuously failed to fulfil the Fed’s mandate to supervise the subprime mortgage market. He was convinced that the market process was so benign – ‘efficient’, in economists’ argot – that supervision was a waste of time.

This was a big step because the unlimited liability associated with partnership acted as a tight control on imprudent behaviour. If a bank failed, creditors had recourse to all the personal assets of the individual partners. Once partnerships turned themselves into joint stock companies, the shareholders still enjoyed unlimited potential for gain but could never lose more than the amount they spent buying shares in the bank. This asymmetry was morally hazardous in that it encouraged greater risk taking. And in the nineteenth and twentieth centuries, commercial banks took more risks by extending their traditional deposit-taking and lending operations into investment banking and securities trading. Investment banking, which consists of issuing and distributing shares on behalf of corporate clients and making markets in shares, has a buccaneering culture wholly different from that of commercial banking.

Financial market practitioners react to these by engaging in regulatory arbitrage, which is relatively easy in a world of global capital flows without a global regulator – banks simply put their business through markets in countries that have less draconian rules. There is always some jurisdiction, after all, in which the rules are looser than in most of the countries where a given bank is domiciled. As risk accumulates in areas that watchdogs find hard to monitor, the seeds of another crisis are sown. Come the crash, another round of imperfect re-regulatory measures is imposed. And so on, indefinitely. This vicious circle, when combined with morally hazardous bailouts when banks go bust, helps explain why there have been more than 100 major banking crises worldwide over the past three decades.49 This process of regulatory escalation can be clearly seen in the Basel capital accords, the international agreements referred to earlier governing the amount of capital banks must maintain. From the capital standards of Basel I in 1988 to the Basel II agreement in 2004, the number of calculations that a large, representative international bank had to make to determine its regulatory capital ratio rose from single figures to over 200 million.50 Much the same has been going on with more detailed re-regulation.


pages: 246 words: 74,341

Financial Fiasco: How America's Infatuation With Homeownership and Easy Money Created the Economic Crisis by Johan Norberg

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accounting loophole / creative accounting, bank run, banking crisis, Bernie Madoff, Black Swan, capital controls, central bank independence, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, David Brooks, diversification, financial deregulation, financial innovation, helicopter parent, Home mortgage interest deduction, housing crisis, Howard Zinn, Hyman Minsky, Isaac Newton, Joseph Schumpeter, Long Term Capital Management, market bubble, Martin Wolf, Mexican peso crisis / tequila crisis, millennium bug, moral hazard, mortgage tax deduction, Naomi Klein, new economy, Northern Rock, Own Your Own Home, price stability, Ronald Reagan, savings glut, short selling, Silicon Valley, South Sea Bubble, The Wealth of Nations by Adam Smith, too big to fail

When the United States got a central bank (the Fed) in 1914, its bank supervisor, the Office of the Comptroller of the Currency, happily declared that "financial and commercial crises or panics ... seem to be mathematically impossible."4 That, unfortunately, was wrong, because another effect was that banks and investors no longer stayed clear of big risks once they knew that they would be bailed out if there was a crisis. In fact, they were all of a sudden given an incentive to act irresponsibly, as they could privatize any gains but socialize any losses. This is usually referred to as "moral hazard." In his classic history of financial crises, Charles Kindleberger explains it thus: "The dilemma is that if investors knew in advance that government support would be forthcoming under generous dispensation when asset prices fall sharply, markets might break down somewhat more frequently because investors will be less cautious in their purchases of assets and of securities."5 What's more, in 1933 the United States introduced deposit insurance, meaning that savers would get their money back even if their bank went out of business.

That may not be a solution that he himself advocates, but he still thinks it would be better than today's system: "Given the frequency of banking crises, this might be a big improvement."' To limit the risk taking that government protection has encouraged, governments may demand to know more about what banks are up to, and if banks get into trouble, they may bail out depositors but let stockholders and senior executives lose their money and jobs. Another way to deal with moral hazard is to require banks not to lend too much relative to their capital. Under Basel I, capital requirements were calculated on the basis of a five-way breakdown of banks' assets. The assets that were deemed not to be in the least dangerous, such as cash or lending to Organization for Economic Cooperation and Development governments, did not count as risks at all, whereas the most precarious assets, such as lending to most corporations, counted at a rate of 100 percent.

Barr, "Moody's Downgrades 691 Mortgage-Backed Securities." 10. Birger, "The Woman Who Called Wall Street's Meltdown." IT. Morgenson, "Debt Watchdogs." 12. Tett and Davies, "Out of the Shadows." 13. Berkshire Hathaway Inc., 2002 Annual Report, p. 13ff. 14. Krugrnan, "After the Money's Gone." 15. Fortune, "101 Dumbest Moments in Business." 16. The Economist, "On Credit Watch." 17. Stafford, "Traders Blind to Mounting Worries." 18. Dowd, "Moral Hazard and the Financial Crisis." 19. Reuters, "`US Homes Market Will Shed Investor Glut."' 20. Hilzenrath, "Fannie's Perilous Pursuit of Subprime Loans." 21. The Economist, "Fannie and Freddie Ride Again"; Duhigg, "Doubts Raised on Big Backers of Mortgages." 22. Duhigg, "At Freddie Mac, Chief Discarded Warning Signs." 23. Paulson, oral statement on regulatory reform; Kopecki, "Fannie, Freddie 'Insolvent' after Losses"; CNBC, "Fannie & Freddie Takeover." 24.


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The Middleman Economy: How Brokers, Agents, Dealers, and Everyday Matchmakers Create Value and Profit by Marina Krakovsky

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Affordable Care Act / Obamacare, Airbnb, Al Roth, Black Swan, buy low sell high, Credit Default Swap, cross-subsidies, crowdsourcing, disintermediation, diversified portfolio, experimental economics, George Akerlof, Goldman Sachs: Vampire Squid, income inequality, index fund, Jean Tirole, Lean Startup, Lyft, Mark Zuckerberg, market microstructure, Martin Wolf, McMansion, Menlo Park, moral hazard, multi-sided market, Network effects, patent troll, Paul Graham, Peter Thiel, pez dispenser, ride hailing / ride sharing, Sand Hill Road, sharing economy, Silicon Valley, social graph, supply-chain management, TaskRabbit, The Market for Lemons, too big to fail, trade route, transaction costs, two-sided market, Uber for X, ultimatum game, Y Combinator

To prosper in a climate of uncertainty, it’s essential to take on risk with an upside. And yet, as the chapters on Certifiers and Enforcers showed, middlemen must be discriminating to avoid adverse selection and moral hazard. Therefore, to profit from risk, middlemen, like successful insurers, must be astute at teasing apart these two types of risk: •Internal risk. This is my term for what finance scholars call counterparty risk, or risk due to the characteristics or actions of a trading partner. In other words, internal risks are risks caused by asymmetric information (adverse selection and moral hazard). Risk-bearing middlemen should avoid internal risk because it can only harm them and their partners on the other side. That’s why, for example, a lender should be wary of lending money to someone with no job and no assets.

Why Services Require Enforcers * * * When you’re selling goods, being a Certifier is enough—you can vouch for the quality of the Prada handbag or the Ben Franklin–era sailboat because these products’ quality is not going to change before it reaches your buyer. Not so with services: regardless of service providers’ underlying ability, they can decide how much effort to put in and how honestly to conduct business. Sussing out hidden information about sellers, as Certifiers do, won’t protect buyers from shirking and cheating, problems that can come up after buyers sign on the dotted line. These problems of shirking and cheating, variously called moral hazard, postcontractual opportunism, or hidden action1—are especially acute when a player’s actions are hidden and when buyers and sellers don’t have an ongoing relationship. An ongoing relationship can protect against such problems, as long as the future value of the relationship is higher than the gains from cheating or shirking today. The lack of such a relationship, on the other hand, gives players an incentive to act opportunistically.

The Promise and the Perils of Sharing Risk * * * It is a general principle that when the party that’s best able to bear the risk does so, both parties are better off. The middleman who is able to bear risk can profit from doing so by charging a risk premium, while the more risk-averse party doesn’t mind paying the risk premium to reduce risk. So why don’t we see middlemen bearing most of the risk? The answer to this risk-sharing question goes back to the old problems of adverse selection and moral hazard. Most economic outcomes in the world are some combination of effort and chance (or skill and luck). How many widgets a sales rep sells, for example, depends on how hard the rep works, how good the rep is at sales to begin with, and factors completely outside the rep’s control, from the quality of the widget to the state of the economy. The rep shouldn’t be held responsible for those external risks, and the company she works for (which has many reps) is in a better position to bear the risk.


pages: 296 words: 87,299

Portfolios of the poor: how the world's poor live on $2 a day by Daryl Collins, Jonathan Morduch, Stuart Rutherford

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Cass Sunstein, clean water, failed state, financial innovation, financial intermediation, income per capita, informal economy, job automation, M-Pesa, mental accounting, microcredit, moral hazard, profit motive, purchasing power parity, RAND corporation, randomized controlled trial, The Fortune at the Bottom of the Pyramid, transaction costs

Salil was in no position to work, nor was his family able to earn much after he died. Dinesh’s illness led to a sell-off of land, and forced his wife to take on added burdens. Only insurance arrangements (or tax-funded public safety nets) can aggregate these kinds of risks, provide urgently needed resources at the right time, and do so without creating additional obligations. Two Sides of Moral Hazard One of the concerns that economists have about insurance is the problem of moral hazard: that being insured for one’s health may also change one’s behavior. The problem arises if the insured start neglecting themselves, knowing they have insurance to cover health problems in the future, which increases the likelihood that they will need insurance. The theorist’s solution—and the one that underpins richworld insurance—is to avoid insuring the whole of the risk.

Providing insurance profitably also entails high-quality actuarial analysis, careful pricing policies, and wise investments: these are complex skills not widely available outside the formal insurance industry, a fact that makes it hard for informal and semiformal providers to compete with formal providers in the way that they have so spectacularly succeeded in doing for microcredit. On the other hand, insurers like those entering the funeral insurance market in South Africa must not only be confident that moral hazard and fraud are kept to a minimum, but, in order to compete successfully with informal schemes, they must bring down the costs and increase the speed of verifying claims and making payouts. They also need better marketing strategies and better ways of spreading risk through market-based tools. 91 CHAPTER THREE Insurers need help reaching the poorer and more remote groups. One solution is to form partnerships between formal insurance companies (who have the know-how in the sophisticated areas of actuarial analysis and investment) and microfinance institutions (who have the outreach to large numbers of poor households).

When insured events are easy to define, extending coverage, such as in life and credit-life insurance, is cheap because it is less risky and requires less paperwork and less checking in the field. This efficiency may apply as much to informal as to formal insurance, helping to explain why community-based funeral coverage has thrived in South 92 DEALING WITH RISK Africa, whereas we found no equivalent in the field of health. Other risks that are insurable in principle, such as crop or livestock loss, are harder to implement in practice because of moral hazard, outright fraud, and documentation difficulties—it is notoriously difficult to know exactly whose cow it was that died, or indeed whether it died of natural causes. Because of these limitations, the poor will continue to face many risks that are not easily insurable. The list of common emergencies in table 3.1 includes, for example, violent crime and the failure to receive a payment. Where financial tools are not available, the result can be emergency asset sales; in the worst cases, those sales strip households of the means to earn future income, triggering a downward spiral toward destitution.


pages: 369 words: 94,588

The Enigma of Capital: And the Crises of Capitalism by David Harvey

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accounting loophole / creative accounting, anti-communist, Asian financial crisis, bank run, banking crisis, Bernie Madoff, Big bang: deregulation of the City of London, Bretton Woods, British Empire, business climate, call centre, capital controls, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, deskilling, equal pay for equal work, European colonialism, failed state, financial innovation, Frank Gehry, full employment, global reserve currency, Google Earth, Guggenheim Bilbao, illegal immigration, indoor plumbing, interest rate swap, invention of the steam engine, Jane Jacobs, joint-stock company, Joseph Schumpeter, Just-in-time delivery, land reform, liquidity trap, Long Term Capital Management, market bubble, means of production, megacity, microcredit, moral hazard, mortgage debt, new economy, New Urbanism, Northern Rock, oil shale / tar sands, peak oil, place-making, Ponzi scheme, precariat, reserve currency, Ronald Reagan, sharing economy, Silicon Valley, special drawing rights, special economic zone, statistical arbitrage, structural adjustment programs, the built environment, the market place, The Wealth of Nations by Adam Smith, Thomas L Friedman, Thomas Malthus, Thorstein Veblen, too big to fail, trickle-down economics, urban renewal, urban sprawl, white flight, women in the workforce

Current chair of the White House’s National Economic Council Larry Summers, in a telling analysis of the effects of government bail-outs on financial behaviour in the wake of the stock market crash of 1987, clearly saw where the problems of moral hazard might lead, but concluded that the effects of government not standing behind financial institutions would be far worse than the effects of always bailing them out. The policy problem was not to avoid but to constrain moral hazard. Unfortunately, when Treasury Secretary in the late 1990s he forgot his own analysis and promoted exactly the kind of unconstrained moral hazard that he had earlier shown might wreck the economy (a clear case of denial in action). Paul Volcker, past chair of the Federal Reserve, warned of a financial crash within five years back in 2004. But majority opinion sided with Ben Bernanke, before he became chair at the Fed, when he said in 2004 that ‘improvements in monetary policy’ had reduced ‘the extent of economic uncertainty confronting households and firms’, thus making recessions ‘less frequent and less severe’.

It was then extended internationally to Mexico in the debt crisis that shook that country to the core in 1982. Put crudely, the policy was: privatise profits and socialise risks; save the banks and put the screws on the people (in Mexico, for example, the standard of living of the population dropped by about a quarter in four years after the financial bail-out of 1982). The result was what is known as systemic ‘moral hazard’. Banks behave badly because they do not have to be responsible for the negative consequences of high-risk behaviour. The current bank bail-out is this same old story, only bigger and this time centred in the United States. In the same way that neoliberalism emerged as a response to the crisis of the 1970s, so the path being chosen today will define the character of capitalism’s further evolution.

The United States promptly reinvigorated the international Monetary Fund (IMF) (which the reagan administration had sought to de-fund in 1981 in accordance with strict neoliberal principle) as the global disciplinarian that would ensure that the banks would get their money back and that the people would be forced to pay up. IMF ‘structural adjustment programs’, which mandated austerity in order to pay back the banks, thereafter proliferated around the world. The result was a rising tide of ‘moral hazard’ in international bank lending practices. For a while, this practice was hugely successful. On the twentieth anniversary of the Mexican bail-out the chief economists from Morgan Stanley hailed it as ‘a factor that set the stage of increasing investor confidence worldwide and helped to ignite the growth market of the late 1990s, along with a strong US economic expansion’. Save the banks and screw the people worked wonders – for the bankers.

Unhappy Union by The Economist, La Guardia, Anton, Peet, John

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bank run, banking crisis, Berlin Wall, Bretton Woods, capital controls, Celtic Tiger, central bank independence, centre right, collapse of Lehman Brothers, credit crunch, Credit Default Swap, debt deflation, Doha Development Round, eurozone crisis, Fall of the Berlin Wall, Flash crash, illegal immigration, labour market flexibility, labour mobility, market fundamentalism, moral hazard, Northern Rock, oil shock, open economy, pension reform, price stability, quantitative easing, special drawing rights, supply-chain management, The Great Moderation, too big to fail, transaction costs, éminence grise

Members of the euro zone do not yet trust each other enough to take on big liabilities in one leap. Reform will have to be done in stages to build confidence. To borrow Schäuble’s phrase about banking union, there could first be a “wooden” structure, followed by a steel one. But if debtors are to agree to more discipline, they need confidence that a system of greater solidarity will follow. Germany has every reason to worry about moral hazard. Weak countries might fail to reform once market pressure is lifted. But moral hazard applies to the strong too: no sooner had fear of the euro’s break-up subsided than Germany started to water down banking union. A plan for greater sharing of liabilities matched by the restoration of a credible no-bail-out rule could prove an attractive bargain. One problem is that many changes would require treaty change. Most leaders, like the institutions in Brussels, recoil at the idea of a big negotiation and multiple referendums at a time when voters are restive, populists are on the rise and incumbents in trouble almost everywhere.

A collapse of the third-largest economy in the euro zone, and its second-largest debtor in absolute terms, would surely sink the euro. Spain mattered not only because it was larger than the other bailed-out states, but also because it was the the last link in the chain of contagion before Italy. The size of the euro zone’s firewall was inadequate because it could not protect Italy. Eurobonds were unacceptable because they would mean Germany having to guarantee Italy’s gargantuan debt. And the fear of moral hazard was acute, in part because nobody trusted Italian politicians to reform. Italy at least had the foresight not to engage in fiscal stimulus, and its primary budget (that is, before interest payments) was in surplus. Moreover, its banks seemed in reasonable shape, and domestic savings were high. Even so, by the start of August its borrowing costs had spiked above the 6% mark (matched by Spain’s yields).

Ahead of the German election due in September 2013, Merkel was wary of taking on new liabilities. She had already lost her “chancellor’s majority” in votes to approve bail-out programmes, meaning that she now had to rely on votes from the opposition Social Democrats. In some ways Draghi’s threat of unlimited intervention worked too well. As pressure from markets eased, so did the pressure to fix the euro zone. The danger of moral hazard did not apply just to debtors; it applied to creditor countries too. Leaders may have pledged to do “whatever it takes”, but more often it was a matter of doing “as little as we can get away with”. Ugliness on Aphrodite’s island The new doctrines of banking union would be tested sooner than expected, in the case of Cyprus. The Commission’s proposed rules on “bail-in” were pencilled in to apply from 2018.


pages: 351 words: 102,379

Too big to fail: the inside story of how Wall Street and Washington fought to save the financial system from crisis--and themselves by Andrew Ross Sorkin

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affirmative action, Asian financial crisis, Berlin Wall, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Fall of the Berlin Wall, fear of failure, fixed income, Goldman Sachs: Vampire Squid, housing crisis, indoor plumbing, invisible hand, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, Mikhail Gorbachev, moral hazard, NetJets, Northern Rock, oil shock, paper trading, risk tolerance, rolodex, Ronald Reagan, savings glut, shareholder value, short selling, sovereign wealth fund, supply-chain management, too big to fail, value at risk, éminence grise

As Bernanke, looking exhausted, sat slumped at a long table in the lodge’s wood-paneled conference room, speaker after speaker stood up to criticize the Fed’s approach to the financial crisis as essentially ad hoc and ineffective, and as promoting moral hazard. Only Alan Blinder, once a Fed vice chairman and a former Princeton colleague of Bernanke’s, defended the Fed. Blinder told this tale: One day a little Dutch boy was walking home when he noticed a small leak in the dike that protected the people in the surrounding town. He started to stick his finger in the hole. But then he remembered the moral hazard lesson he had learned in school. . . . “The companies that built this dike did a terrible job,” the boy said. “They don’t deserve a bailout, and doing so would just encourage more shoddy construction. Besides, the foolish people who live here should never have built their homes on a floodplain.”

The previous day, Bernanke, in his address to the symposium, had made a plea to move beyond a finger-in-the-dike strategy, by urging Congress to create a “statutory resolution regime for nonbanks.“ “A stronger infrastructure would help to reduce systemic risk,” Bernanke noted. It would also mitigate moral hazard and the problem of ”too big to fail” by reducing the range of circumstances in which systemic stability concerns might be expected by markets to prompt government intervention. A statutory resolution regime for nonbanks, besides reducing uncertainty, would also limit moral hazard by allowing the government to resolve failing firms in a way that is orderly but also wipes out equity holders and haircuts some creditors, analogous to what happens when a commercial bank fails. Bernanke did not mention Fannie or Freddie, but their fate was on the minds of many at Jackson Hole.

Then Lauer, quoting from the front page of the Wall Street Journal, asked, “‘Has the government set a precedent for propping up failing financial institutions at a time when its more traditional tools don’t appear to be working?’ In other words, they’re saying, is this now the wave of the future, Mr. Secretary? That financial institutions that get in trouble in the future turn to the government to get bailed out?” It was a particularly poignant question; only nights before Paulson had railed on a conference call with all the Wall Street’s CEOs about “moral hazard”—that woolly economic term that describes what happens when risk-takers are shielded from the consequences of failure; they might take ever-greater risks. “Well, again, as I said, I don’t believe the Bear Stearns shareholders feel they’ve been bailed out right now,” Paulson repeated. “The focus is clearly, all of our focus is on what’s best for the American people and how to minimize the impact of the disruption in the capital markets.” 018 When she sat down at her desk Callan turned on her Bloomberg terminal and waited for Goldman Sachs to announce its results for the quarter, which the market would take as a rough barometer of the shape of things to come.


pages: 580 words: 168,476

The Price of Inequality: How Today's Divided Society Endangers Our Future by Joseph E. Stiglitz

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affirmative action, Affordable Care Act / Obamacare, airline deregulation, Andrei Shleifer, banking crisis, barriers to entry, Basel III, battle of ideas, Berlin Wall, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, collapse of Lehman Brothers, collective bargaining, colonial rule, corporate governance, Credit Default Swap, Daniel Kahneman / Amos Tversky, Dava Sobel, declining real wages, deskilling, Exxon Valdez, Fall of the Berlin Wall, financial deregulation, financial innovation, Flash crash, framing effect, full employment, George Akerlof, Gini coefficient, income inequality, income per capita, indoor plumbing, inflation targeting, invisible hand, John Harrison: Longitude, John Maynard Keynes: Economic Possibilities for our Grandchildren, Kenneth Rogoff, labour market flexibility, London Interbank Offered Rate, lone genius, low skilled workers, Mark Zuckerberg, market bubble, market fundamentalism, medical bankruptcy, microcredit, moral hazard, mortgage tax deduction, obamacare, offshore financial centre, paper trading, patent troll, payday loans, price stability, profit maximization, profit motive, purchasing power parity, race to the bottom, rent-seeking, reserve currency, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, Simon Kuznets, spectrum auction, Steve Jobs, technology bubble, The Chicago School, The Fortune at the Bottom of the Pyramid, The Myth of the Rational Market, The Spirit Level, The Wealth of Nations by Adam Smith, too big to fail, trade liberalization, transaction costs, trickle-down economics, ultimatum game, uranium enrichment, very high income, We are the 99%, women in the workforce

They did set aside about $50 billion from the Toxic Asset Relief Program for mortgage restructuring, but interestingly, the Obama administration has spent only about $3.4 billion of this amount—suggesting that it was the resistance of the banks, more than the money itself, that has been the real impediment to restructuring. 48. Even the use of the term “moral hazard” (as opposed the more neutral term “incentive effects”) has emotive overtones, suggesting that there is something immoral about these particular incentive responses. As the University of Pennsylvania law professor Tom Baker put it, the term “helps deny that refusing to share [the burdens of life] is mean-spirited or self-interested.” (Quoted in Shaila Dewan, “Moral Hazard: A Tempest-tossed Idea,” New York Times, February 26, 2012, p. BU1.) In fact, there is little evidence that there would be serious “moral hazard consequences” even of a generous program to help homeowners. Shaun Donovan, secretary of the Department of Housing and Urban Development, argues that “only about 10 or 15 percent of Americans who can still pay their mortgages try to walk away from their debt.”

Shaun Donovan, secretary of the Department of Housing and Urban Development, argues that “only about 10 or 15 percent of Americans who can still pay their mortgages try to walk away from their debt.” Ibid. The general theory of moral hazard was developed in the midsixties and seventies by Arrow, Mirrlees, Ross, and Stiglitz. See, e.g., Kenneth Arrow, Aspects of the Theory of Risk Bearing (Helsinki, Finland: Yrjö Jahnssonin Säätiö, 1965); James Mirrlees, “The Theory of Moral Hazard and Unobservable Behaviour I,” Review of Economic Studies 66, no. 1 (1999): 3–21; S. Ross, “The Economic Theory of Agency: The Principal’s Problem,” American Economic Review 63, no. 2 (1973): 134–39; and J. E. Stig-litz, “Incentives and Risk Sharing in Sharecropping,” Review of Economic Studies 41, no. 2 (1974): 219–55. For a broader discussion of the term, see Tom Baker, “On the Genealogy of Moral Hazard,” Texas Law Review 75 (1996): 237. 49. Also UK regulators are pushing for new power of automatic sanctions of senior bank executives for poor decisions they make that lead to bank failures.

Furthermore, offering relief to homeowners would exacerbate the problem of moral hazard: if individuals were left off the hook, it would undermine incentives to repay.48 What was curious about these arguments was that they could have applied just as easily, and with greater force, to the banks. The banks had repeatedly been bailed out. The Mexican bailout of 1995, the Indonesian, Thai, and Korean bailouts of 1997–98, the Russian bailout of 1998, the Argentinean bailout of 2000, these and others were all really bank bailouts, though they carried the name of the country where banks had lent excessively. Then, in 2008–09, the U.S. government was engaged in yet another bailout, this one the most massive ever. The banks had proven the relevance of moral hazard—bank bailouts had repeatedly and predictably led to excessive risk taking by banks—and yet both the Bush and the Obama administrations ignored it and refused to discourage future bad behavior by, for instance, firing executives (as the UK did)49 or making shareholders and bondholders take a hit.50 Unlike the banks, most of the people losing their homes were not repeat offenders.


pages: 348 words: 99,383

The Financial Crisis and the Free Market Cure: Why Pure Capitalism Is the World Economy's Only Hope by John A. Allison

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Affordable Care Act / Obamacare, bank run, banking crisis, Bernie Madoff, clean water, collateralized debt obligation, correlation does not imply causation, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, disintermediation, fiat currency, financial innovation, Fractional reserve banking, full employment, high net worth, housing crisis, invisible hand, life extension, low skilled workers, market bubble, market clearing, minimum wage unemployment, moral hazard, obamacare, price mechanism, price stability, profit maximization, quantitative easing, race to the bottom, reserve currency, risk/return, Robert Shiller, Robert Shiller, The Bell Curve by Richard Herrnstein and Charles Murray, too big to fail, transaction costs, yield curve

In fact, let me tell you a story to help you grasp the moral hazard risk. In the fall of 2008, I was visiting BB&T’s mortgage collection center to try to boost the morale of our employees. One of our collectors whom I had known for a long time handed me a phone call from a client. This client had moved from the Northeast to Florida about 18 months before. He had purchased a $1,000,000 house, and BB&T had made him a $600,000 loan. According to this individual, the house was now worth $500,000. He wanted us to reduce his interest rate from 5½ percent to 3 percent and forgive $100,000 of his debt. Interestingly, he had $800,000 on deposit with the bank. I asked him whether, if the house had appreciated to $2,000,000, he would have given us the $1,000,000 gain. I don’t think so. Moral hazard is a real risk. There is also a significant job-destroying effect of not letting the housing market correct.

In October 2010, as an ex-CEO, Mozilo settled out of court on civil fraud charges for misleading investors on risky mortgages, but Countrywide’s buyer (Bank of America) ended up paying most of the $67 million to the SEC. Bank of America also paid $600 million to settle a class-action lawsuit filed by Countrywide’s robbed shareholders. 6. See Bert Ely, “Financial Innovation and Deposit Insurance: The 100% Cross-Guarantee Concept,” Cato Journal (Winter 1994), pp. 413–445, and Bert Ely, “Regulatory Moral Hazard: The Real Moral Hazard in Federal Deposit Insurance,” Independent Review (Fall 1999), pp. 241–254. 7. See Michael Keeley, “Deposit Insurance, Risk, and Market Power in Banking,” American Economic Review (1980), pp. 1183–1200, and Gary Gorton and Richard Rosen, “Corporate Control, Portfolio Choice and the Decline of Banking,” Journal of Finance (1995), pp. 1377–1420. 8. See Dennis Cauchon, “Federal Workers Earning Double Their Private Counterparts,” USA Today, August 13, 2010, http://www.usatoday.com/money/economy/income/2010-08-10-1Afedpay10_ST_N.htm. 9.

Determining the right price for the troubled assets was simply not practical. Also, most of the troubled assets were bonds backed by home mortgages. Was the federal government ready to orchestrate a massive foreclosure program at the same time the administration was encouraging private lenders to have forbearance? If the delinquent mortgages were not foreclosed on, would that have created a huge moral hazard effect, with many underwater homeowners simply deciding not to pay their home loans because they knew that their homes would not be foreclosed? I was adamantly against TARP, as originally proposed, for a number of reasons. First, it was clear that it would not work. In addition, it was a blatantly obvious effort to bail out the giant money-center banks and the investment banks. The troubled assets were basically rated bonds backed by home mortgages that were held in the investment portfolios of these major financial institutions.


pages: 823 words: 206,070

The Making of Global Capitalism by Leo Panitch, Sam Gindin

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accounting loophole / creative accounting, airline deregulation, anti-communist, Asian financial crisis, asset-backed security, bank run, banking crisis, barriers to entry, Basel III, Big bang: deregulation of the City of London, bilateral investment treaty, Branko Milanovic, Bretton Woods, BRICs, British Empire, call centre, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collective bargaining, continuous integration, corporate governance, Credit Default Swap, crony capitalism, currency manipulation / currency intervention, currency peg, dark matter, Deng Xiaoping, disintermediation, ending welfare as we know it, eurozone crisis, facts on the ground, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, floating exchange rates, full employment, Gini coefficient, global value chain, guest worker program, Hyman Minsky, imperial preference, income inequality, inflation targeting, interchangeable parts, interest rate swap, Kenneth Rogoff, land reform, late capitalism, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, manufacturing employment, market bubble, market fundamentalism, Martin Wolf, means of production, money: store of value / unit of account / medium of exchange, Monroe Doctrine, moral hazard, mortgage debt, mortgage tax deduction, new economy, non-tariff barriers, Northern Rock, oil shock, precariat, price stability, quantitative easing, Ralph Nader, RAND corporation, regulatory arbitrage, reserve currency, risk tolerance, Ronald Reagan, seigniorage, shareholder value, short selling, Silicon Valley, sovereign wealth fund, special drawing rights, special economic zone, structural adjustment programs, The Chicago School, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, trade liberalization, transcontinental railway, trickle-down economics, union organizing, very high income, Washington Consensus, Works Progress Administration, zero-coupon bond

Japan displayed its usual “follow-the-leader mentality” in a case where “neither transnational institutional linkages nor interest in the Mexican rescue were strong.”27 On the other hand, the IMF directors from Germany, the UK, the Netherlands, Belgium, Switzerland, and Norway registered their discomfort with the Treasury’s ultimatum (the Executive Board was given only twenty-four hours to look at the plan) by abstaining on the vote. But this was “as strong a diplomatic sign of disapproval as they felt they could send without undermining the rescue”; they recognized that more than their aversion to “moral hazard” would be at stake if “one of the shining stars of market-oriented reform in the developing world . . . became an international financial pariah.”28 In response to Germany’s continued harping about moral hazard, the IMF’s chief economist, Michael Mussa, commented tersely: “And if we hadn’t rescued 800 people from the Titanic, we would have taught everyone an even more valuable lesson about the dangers of ocean travel.”29 If this crisis was indeed the harbinger of a new level of global financial instability, what was just as significant was that the Mexican crisis was, to a remarkable degree, effectively contained.

The UK’s 1973 “secondary banking” crisis, which was also due to the collapse of a real-estate bubble, “threatened some of the biggest financial institutions with the real risk of collapse.”86 Moreover, a broad range of European banks were revealing major losses amid the volatility in short-term capital flows that were initially triggered by both floating currencies and the recycling of petrodollars. This came to a head in June 1974, when the Bundesbank allowed Bankhaus I.D. Herstatt of Cologne, one of Germany’s largest private banks, to collapse. Apart from the Bundesbank’s traditional obsession with a tight monetary policy, this was justified in terms of avoiding “moral hazard’—that is, “to teach speculators, as well as banks dealing with speculators, a lesson.”87 But in contrast to the carefully managed Franklin crisis that the Fed and OCC were engaged in, the consequence of the Bundesbank’s action was that the Herstatt crisis immediately spilled over to the international interbank lending markets, including nearly collapsing the New York clearing house, CHIPS, which connects the dozen or so largest US banks with major banks around the world in processing payments among them primarily related to foreign exchange transactions.

The pattern of letting banks that were too small to matter go under, while acting as lender of last resort to save the ones that were “too big to fail” was set in 1982, when Volcker bluntly told the Federal Open Market Committee (FOMC): “If it gets bad enough, we can’t stay on the side or we’ll have a major liquidity crisis. It’s a matter of judgment as to when and how strongly to react. We are not here to see the economy destroyed in the interest of not bailing somebody out.”78 The “moral hazard” tightrope that the state had to walk in this respect was nothing compared with the practical hazard involved in figuring out whether allowing even a small bank to collapse might have systemic effects. This was vividly demonstrated in the summer of 1982, when the decision to close a small Oklahoma bank, Penn Square, immediately endangered Continental Illinois, the sixth-largest commercial bank in the US, which then immediately turned to the international interbank market for its funding.


pages: 225 words: 11,355

Financial Market Meltdown: Everything You Need to Know to Understand and Survive the Global Credit Crisis by Kevin Mellyn

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asset-backed security, bank run, banking crisis, Bernie Madoff, bonus culture, Bretton Woods, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, disintermediation, diversification, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Francis Fukuyama: the end of history, global reserve currency, Home mortgage interest deduction, Isaac Newton, joint-stock company, liquidity trap, London Interbank Offered Rate, margin call, market clearing, moral hazard, mortgage tax deduction, Northern Rock, offshore financial centre, paradox of thrift, pattern recognition, pension reform, pets.com, Plutocrats, plutocrats, Ponzi scheme, profit maximization, pushing on a string, reserve currency, risk tolerance, risk-adjusted returns, road to serfdom, Ronald Reagan, shareholder value, Silicon Valley, South Sea Bubble, statistical model, The Great Moderation, the payments system, too big to fail, value at risk, very high income, War on Poverty, Y2K, yield curve

The problem is that almost all regulatory compliance is maintained by ticking boxes or filling in numbers on forms. Both the banks and regulators end up going through the motions. It is hard to name a single banking crack-up that was ever spotted and prevented by formal regulatory procedures in any jurisdiction. MORAL HAZARD Meanwhile, the fact that deposits are insured by the government motivates everyone from depositors to bankers to politicians to act like spoiled children instead of grown-ups. Economists call this The Limits of Financial Regulation infantilization of conduct ‘‘moral hazard.’’ Basically, moral hazard is what happens when you remove consequences for risky behavior. If you know in advance that the judge will let you off if you are stopped for a DWI, you might be inclined to drive with a few drinks in you. If you know that nothing bad will happen to you even if you cause an accident, the temptation to party hearty may be too much.

Fairness requires that government work to reverse the most troubling aspect of the free market: There are always a few winners and many losers, and many of the winners start life on third base. Conveniently, the few cannot defend their property in a system of universal elective franchise where majorities rule, a point that the great Victorian legal scholar A.V. Dicey made in arguing that letting people who got more out of the state than they paid in tax constituted a moral hazard. Politicians would always grab more and more from the few and spend it to buy political power through providing financial security to the many. Representation without taxation leads as certainly to tyranny as taxation without representation. ILLIBERALISM The New Deal and FDR’s four presidential victories prove that Dicey was on to something, as does the perennial power of socialist parties 181 182 Conclusion in European electoral politics.

See also ‘‘black swans’’ Long Term Credit Bank (LTCB), Japan, 170 195 196 Index Mackay, Charles, Great Popular Delusions and the Madness of Crowds, 136 Madoff, Bernard, 23, 175 Main Street, 1, 91, 104, 144, 176, 187 Manias, xviii–xx, 27, 109, 136–138 Manufacturers Hanover Trust Company, 148, 158 margin lending, 110 market capitalization, 47, 51, 70, 126, 159, 183 markets 19–22, 24–28, 40–41, 60, 72, 107, 111, 117–119, 124, 126–127, 150, 165–169, 175–176; 179–189; defined, xi–xx; functions, 18–28; history of, 75, 79–89, 135–145; how to play, 50–56; irrational, 52–53, 156–57; real estate market downturn and ‘‘Billy Bob’’ banking crisis, 131–32; secondary, 44 MBS (Mortgage Backed Securities), 57 Medici, 79 Meyer, Martin, Bankers, The, 143 MMA (Money Market Account), 130 models, uses in finance, 21, 25, 27, 63–65, 69–70, 99–100, 138, 152, 166, 171, 177, 182; faith in, 4, 58, 66, 68, 71–72, 74 MOF (Ministry of Finance, Japan), 167 money, creation of, 13; defined, x, xi, 117; history of, xv–xvi, 33–34, 77–80; function of, xii–xv; money supply, types of xv, xvii–xviii, 4, 8–9, 83, 92, 148, 155; value of, 4. See also Credit money, Coinage, Commodity money, Deposit money, Paper money money market, 4, 6, 13, 23, 41–42, 84, 86–87, 90, 102, 106, 108, 110, 130, 150, 167 monoline credit insurers, 66 monopoly, 65, 81, 84–85, 95–96, 124; clearing and settlement, 13; deposit taking, 12, 15, 19, 90 Monte dei Paschi di Siena, bank, 79 ‘‘moral hazard,’’ 128–129, 181 Morgan Bank, 87, 108, 142–143 Morgan, J.P., 103, 105, 121, 164 Mortgages, 7, 18, 25, 35, 41, 55–58, 61–64, 66, 71–73, 110, 113, 121, 130–134, 142, 165, 176, 185, 187 NASDAQ, 165 National Accounts (US), 6, 113 National Bank Act of 1864 (US), 38 negotiable instrument, 10, 33, 35, 38–39, 130, 145 New Deal, 56, 114, 117, 126, 128, 130, 141–143, 154, 158–159, 162–163, 166, 176, 181–182, 184, 187, 189 Newton, Sir Isaac, 137 Nikkei, stock index, 168, 171 Nixon, Richard M., 154–155 Northern Rock, 86 NOW (Negotiable Order of Withdrawal) account, 130 off-shore banking centers, 150 open market operations, 107–108, 145 OPM or ‘‘Other People’s Money,’’ 15–19, 22, 26–27, 39, 46, 61, 71, 87–88, 92–93, 104, 129, 144–145, 150, 165, 167 Index ‘‘options,’’ 54–55, 75, 77 overdraft, 37–38, 61, 78, 89–90 Pac-Man banking, 157, 159 panics, xix–xx, 2, 5, 19, 45, 48, 98, 102, 109–10, 121, 136, 140–141, 150, 164, 183; of 1873, 5, 103; of 1907, 103; of 2008, 52; use of, 139 ‘‘paper money,’’ xiv–xvi, 14, 29, 33, 35, 83, 97.


pages: 183 words: 17,571

Broken Markets: A User's Guide to the Post-Finance Economy by Kevin Mellyn

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banking crisis, banks create money, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, Bonfire of the Vanities, bonus culture, Bretton Woods, BRICs, British Empire, call centre, Carmen Reinhart, central bank independence, centre right, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, credit crunch, crony capitalism, currency manipulation / currency intervention, disintermediation, eurozone crisis, fiat currency, financial innovation, financial repression, floating exchange rates, Fractional reserve banking, global reserve currency, global supply chain, Home mortgage interest deduction, index fund, joint-stock company, Joseph Schumpeter, labor-force participation, labour market flexibility, liquidity trap, London Interbank Offered Rate, lump of labour, market bubble, market clearing, Martin Wolf, means of production, mobile money, moral hazard, mortgage debt, mortgage tax deduction, Ponzi scheme, profit motive, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, reserve currency, rising living standards, Ronald Coase, seigniorage, shareholder value, Silicon Valley, statistical model, Steve Jobs, The Great Moderation, the payments system, Tobin tax, too big to fail, transaction costs, underbanked, Works Progress Administration, yield curve, Yogi Berra

If the authorities rescued Bear Stearns, a distinctly down-market franchise deep in the mortgage mire, surely they would not let Lehman fail. Of course, the US government did let Lehman fail, partially because the Federal Reserve did not have the authority it needed to bail out an investment bank. But the authorities also feared that doing so—and in effect reinforcing the idea that no major firm would be allowed to fail under any circumstances—would give rise to an extremely dangerous level of moral hazard in the financial markets. Moral hazard is an economic term for how people behave when their actions have no downside. Successful and often repeated rescues of the financial economy during the Greenspan years had led to a situation of “Heads, I win; tails, the government pays.” Sometimes this is referred to as private profits and socialized losses, and even deposit insurance is tainted with the same problem. If the government will make you whole when a bank fails, why not deposit your savings with the bank offering the highest rates, even if it might be a bit dodgy?

What made the event so shocking was that the Great Moderation had taught the global financial economy that a large market player with huge obligations to and from other key players would somehow be saved. Certainly Lehman’s management must have made this assumption. After all, Bear Stearns, a far less important house with more to answer for in the mortgage securities bubble, had been rescued. Surely, the authorities could see the domino effect that would occur if they let Lehman go down? Economists use the term moral hazard to describe what happens when the consequences of bad decisions are eliminated. For example, deposit insurance means you don’t have to evaluate the soundness of your bank. Uncle Sam will always make you whole if it goes bust.What would happen if deposit insurance was abolished overnight during a market panic? There would be a run on the banks as people rushed to turn their deposits into cash before the cash ran out.

This lender-of-last-resort function is fundamental to central banking, but creates great risks to the taxpayer, so it logically requires that the central bank have an ability to supervise the behavior of private-sector banks. Otherwise, the very fact that someone is willing and able to bail them out of the consequences of risky behavior in fact provides incentives to the private-sector banks for that behavior—a concept knows as a moral hazard, as mentioned previously. The second key reason why some degree of financial regulation is legitimate is that deposit money in banks forms the basis of the payments system. Payments system is an arcane term for all the institutions and mechanisms that allow one person or organization to transfer monetary claims to another. Wire transfers, checks, and plastic cards all play a role in the payments system, as does paper money.There are many parties involved, including consumers, merchants, utilities and other billers, and key infrastructure such as ATM switches and clearinghouses.


pages: 510 words: 120,048

Who Owns the Future? by Jaron Lanier

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3D printing, 4chan, Affordable Care Act / Obamacare, Airbnb, augmented reality, automated trading system, barriers to entry, bitcoin, book scanning, Burning Man, call centre, carbon footprint, cloud computing, computer age, crowdsourcing, David Brooks, David Graeber, delayed gratification, digital Maoism, en.wikipedia.org, facts on the ground, Filter Bubble, financial deregulation, Fractional reserve banking, Francis Fukuyama: the end of history, George Akerlof, global supply chain, global village, Haight Ashbury, hive mind, if you build it, they will come, income inequality, informal economy, invisible hand, Jacquard loom, Jaron Lanier, Jeff Bezos, job automation, Kevin Kelly, Khan Academy, Kickstarter, Kodak vs Instagram, life extension, Long Term Capital Management, Mark Zuckerberg, meta analysis, meta-analysis, moral hazard, mutually assured destruction, Network effects, new economy, Norbert Wiener, obamacare, packet switching, Peter Thiel, place-making, Plutocrats, plutocrats, Ponzi scheme, post-oil, pre–internet, race to the bottom, Ray Kurzweil, rent-seeking, reversible computing, Richard Feynman, Richard Feynman, Ronald Reagan, self-driving car, side project, Silicon Valley, Silicon Valley ideology, Silicon Valley startup, Skype, smart meter, stem cell, Steve Jobs, Steve Wozniak, Stewart Brand, Ted Nelson, The Market for Lemons, Thomas Malthus, too big to fail, trickle-down economics, Turing test, Vannevar Bush, WikiLeaks

The big kinds of computation that have made certain other industries like music “efficient” from a particular point of view were applied to finance, and that broke finance. It made finance stupid. Consider the expansion of the financial sector prior to the Great Recession. It’s not as if that sector was accomplishing any more than it ever had. If its product is to manage risk, it clearly did a terrible job. It expanded purely because of its top positions on networks. Moral hazard has never met a more efficient amplifier than a digital network. The more influential digital networks become, the more potential moral hazard we’ll see, unless we change the architecture. A First Pass at a Definition A Siren Server, as I will refer to such a thing, is an elite computer, or coordinated collection of computers, on a network. It is characterized by narcissism, hyperamplified risk aversion, and extreme information asymmetry. It is the winner of an all-or-nothing contest, and it inflicts smaller all-or-nothing contests on those who interact with it.

Unfortunately, these two voices, which have functioned as opposites, checking each other for centuries, have been confounded into idiotic agreement and collusion with the appearance of digital network technology. Upon hearing that I propose that people be able to earn their livings in part just for doing what they do while being watched by cloud algorithms, the parent voice can be expected to say: “Doing what you want shouldn’t be a way of earning a living. Allowing even a hint of that is the very core of moral hazard. The moment kids get a whiff of the notion, they’ll never learn to take on the sheer pain of growing up—or the self-sacrifice of doing a job or paying a mortgage—and civilization will fall apart.” The child voice doesn’t listen to any of this, naturally, but instead demands exactly the same thing using a different argument: “Why bring money into it? Money is all about greed and getting ahead and getting old and boring.

Living languages ought to require continued examples from living people in order for automated translation services to stay up to date. If the cloud has learned all it will ever need to learn to translate between English and Chinese, it means those languages have become fixed. People ought to be in the driver’s seat and not allow the network to define and capture a language for all time. A humanistic economy would remove moral hazards that might incentivize artificial language stasis, and other similar traps. If a language translation service becomes so refined that it requires only one one-hundredth of the data gathering it did in its early years, just to keep up to date with new expressions, then that service should not be surprised to pay a hundred times more for a given amount of the latest data it requires. I expect to hear familiar objections.


pages: 411 words: 108,119

The Irrational Economist: Making Decisions in a Dangerous World by Erwann Michel-Kerjan, Paul Slovic

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Andrei Shleifer, availability heuristic, bank run, Black Swan, Cass Sunstein, clean water, cognitive dissonance, collateralized debt obligation, complexity theory, conceptual framework, corporate social responsibility, Credit Default Swap, credit default swaps / collateralized debt obligations, cross-subsidies, Daniel Kahneman / Amos Tversky, endowment effect, experimental economics, financial innovation, Fractional reserve banking, George Akerlof, hindsight bias, incomplete markets, invisible hand, Isaac Newton, iterative process, Loma Prieta earthquake, London Interbank Offered Rate, market bubble, market clearing, moral hazard, mortgage debt, placebo effect, price discrimination, price stability, RAND corporation, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, statistical model, stochastic process, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, too big to fail, transaction costs, ultimatum game, University of East Anglia, urban planning

The efficiency and equity issues raised by this kind of assistance are discussed in the next section. Another challenge is that badly designed insurance contracts can discourage investments in loss prevention or even encourage negligent behavior (“If I know I’m protected anyway, I can take more risk”), commonly referred to in economics as moral hazard or in the climate community as maladaptation. As a remedy, index-based contracts, by decoupling losses and claims, avoid moral hazard and can provide strong incentives for risk-reducing interventions and lifestyle changes. Two of my earlier examples illustrate this: In Mongolia, insured herders will face increasing premiums as climate change worsens weather conditions, giving them an added incentive to change their livelihood if animal husbandry becomes unproductive; and in Mexico, government officials will face higher interest on their catastrophe bonds by not taking measures to reduce risks to public infrastructure.

CONCLUSION: REFRAMING THE DISCUSSION AS A PREREQUISITE FOR REFORM It is no secret that the current (and long-standing) federal approach to financing disaster losses is far from perfect. Since disaster risk is spread unevenly across the country, financing federal relief out of general revenues involves large cross-subsidies, from low-risk to high-risk areas. Many critics claim, moreover, that generous federal relief creates a large “moral hazard” problem, ensuring greater losses over the long term by encouraging building in hazard-prone areas and generally reducing incentives for investment in preventive measures. Nor is there any lack of good policy alternatives. One reasonable option would be to make private disaster insurance mandatory and to create a federal reinsurance program, allowing private insurers to transfer some portion of the risk to the government reinsurance agency, in return for an appropriate premium.

It is clear and reasonable that different individuals have access to different information; they have varying life experiences and varying opportunities to make observations. A number of economists came to stress this concept from varying points of view; I myself came to it by considering the economics of medical care (Arrow, 1963).4 Insurance companies had long understood the consequences of asymmetry of information under such headings as moral hazard and adverse selection. It is not always recognized that the most neoclassical approaches in economics also assume asymmetry of information. It is a standard claim for the usefulness of a system of markets that it requires an individual to know only his or her own utility function and production possibilities. The only information about the rest of the world is contained in the prices. This has an implication for the relation between contingent contracts in general and the limited set of contingent claims on exogenous events that Debreu and I had postulated in our treatment of general equilibrium under uncertainty.


pages: 376 words: 109,092

Paper Promises by Philip Coggan

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accounting loophole / creative accounting, balance sheet recession, bank run, banking crisis, barriers to entry, Berlin Wall, Bernie Madoff, Black Swan, Bretton Woods, British Empire, call centre, capital controls, Carmen Reinhart, carried interest, Celtic Tiger, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, debt deflation, delayed gratification, diversified portfolio, eurozone crisis, Fall of the Berlin Wall, falling living standards, fear of failure, financial innovation, financial repression, fixed income, floating exchange rates, full employment, German hyperinflation, global reserve currency, hiring and firing, Hyman Minsky, income inequality, inflation targeting, Isaac Newton, joint-stock company, Kenneth Rogoff, labour market flexibility, Long Term Capital Management, manufacturing employment, market bubble, market clearing, Martin Wolf, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Nick Leeson, Northern Rock, oil shale / tar sands, paradox of thrift, peak oil, pension reform, Plutocrats, plutocrats, Ponzi scheme, price stability, principal–agent problem, purchasing power parity, quantitative easing, QWERTY keyboard, railway mania, regulatory arbitrage, reserve currency, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, short selling, South Sea Bubble, sovereign wealth fund, special drawing rights, The Chicago School, The Great Moderation, The Wealth of Nations by Adam Smith, time value of money, too big to fail, trade route, tulip mania, value at risk, Washington Consensus, women in the workforce

Creditors tend to believe that a borrower should honour his debts as a matter of principle; ‘they hired the money, didn’t they?’ as 1920s US President Calvin Coolidge remarked when faced with his allies’ requests to reschedule First World War debts. The idea that borrowers should be allowed to escape is one example of ‘moral hazard’ in economics. Let the borrowers believe they will be rescued from their folly, the tone implies, and they will never meet their responsibilities. The concept of moral hazard persuaded the US authorities not to rescue the investment bank Lehman Brothers in September 2008, a decision that almost brought the global financial system to a halt. The debtors also appeal to morality. They argue that creditors demand too high a price for lending money. Such income is ‘unearned’, in contrast to the wages received by the honest worker.

‘We shall have no means after the war out of which we can pay for purchases in the United States except the equivalent of what they buy from us,’ he said.2 In contrast, White recognized that the larger the bailout fund, the bigger the bill for the US, which as the biggest creditor would have to stand behind it. Indeed, even if White had been sympathetic to Keynes’s ambitions, he had to deal with congressional opposition to a large US commitment. One newspaper feared that ‘Uncle Sam would be treated as an Uncle Sap for the rest of the world’.3 The concept of a domestic lender of last resort had always been dogged by moral hazard. What was to stop a bank from taking excessive risks if it believed the central bank stood behind it? The same was true at the international level. Would the IMF act as a sugar daddy to deficit nations and prevent them from making the required policy changes to address their own problems? The initial proposal of Keynes was for a ‘clearing union’ in which international trade balances would be settled.

The relationship between central banks, markets and debt levels has already been mentioned; when markets falter central banks cut interest rates, thus encouraging investors to take more risk. There is also another spiral at work involving banks and governments. Governments support banks, so banks get bigger, requiring more government support. One study found that deposit insurance schemes increased fourfold, relative to GDP, in the wake of a financial crisis.16 This leads to a ‘moral hazard’ problem. Depositors have no incentive to monitor the health of their banks since governments stand behind them and will guarantee their deposits. That was how British savers became exposed to an Icelandic bank. Banks ceased to compete on safety. Instead they competed to attract shareholders by the size of their profits, creating the incentive to take more risk. The banks profited when their bets paid off, but the taxpayer ended up with the bill when the bets were unsuccessful.


pages: 285 words: 86,174

Twilight of the Elites: America After Meritocracy by Chris Hayes

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affirmative action, Affordable Care Act / Obamacare, asset-backed security, barriers to entry, Berlin Wall, Bernie Madoff, carried interest, Climategate, Climatic Research Unit, collapse of Lehman Brothers, collective bargaining, Credit Default Swap, dark matter, David Brooks, David Graeber, deindustrialization, Fall of the Berlin Wall, financial deregulation, fixed income, full employment, George Akerlof, hiring and firing, income inequality, Jane Jacobs, jimmy wales, Julian Assange, Mark Zuckerberg, mass affluent, means of production, meta analysis, meta-analysis, moral hazard, Naomi Klein, Nate Silver, peak oil, Plutocrats, plutocrats, Ponzi scheme, Ralph Waldo Emerson, rolodex, The Spirit Level, too big to fail, University of East Anglia, We are the 99%, WikiLeaks, women in the workforce

A society in which cheaters, shirkers, and incompetents face no sanction, where bad behavior meets reward, is a morally hazardous one. In economics, the term “moral hazard” refers to the perverse incentives that can arise when agents are insulated from the cost of their actions: A hypochondriac with a health insurance plan that covers the full cost of doctor’s visits will make more appointments than one who has a sizable co-pay; a banker who knows at some level that the cost of catastrophically bad bets will ultimately be picked up by the government has far less incentive to avoid blowing everything up while in the zealous pursuit of the highest yield possible. One way to understand the financial crisis is as the natural result of moral hazard: major financial institutions only took the risks they did because at some institutional level they assumed that if things went terribly wrong the government wouldn’t let them fail.

United States—Social conditions—21st century. I. Title. HN90.E4H39 2012 305.5’20973—dc23 2012002435 eISBN: 978-0-307-72047-4 Jacket design by Ben Wiseman Jacket photography © Ryan McVay/Getty Images v3.1 To my mom and dad, who taught me how to see the world. Contents Cover Title Page Copyright Dedication Chapter One THE NAKED EMPERORS Chapter Two MERITOCRACY AND ITS DISCONTENTS Chapter Three MORAL HAZARDS Chapter Four WHO KNOWS? Chapter Five WINNERS Chapter Six OUT OF TOUCH Chapter Seven REFORMATION Acknowledgments Notes Selected Bibliography About the Author Chapter 1 THE NAKED EMPERORS Now see the sad fruits your faults produced, Feel the blows you have yourselves induced. — RACINE AMERICA FEELS BROKEN. Over the last decade, a nation accustomed to greatness and progress has had to reconcile itself to an economy that seems to be lurching backward.

It would reflexively protect its worst members, it would operate with a wide gulf between performance and reward, and would be shot through with corruption, rule-breaking, and self-dealing as those on top pursued the outsize rewards promised for superstars. In the way the bailouts combined the worst aspects of capitalism and socialism, such a social order would fuse the worst aspects of meritocracy and bureaucracy. It would, in other words, look a lot like the American elite circa 2012. Chapter 3 MORAL HAZARDS The bargain has been breached.… The American people do not think the system is fair, or on the level. —JOE BIDEN ON THE MORNING OF FEBRUARY 18, 2010, ANDREW Joseph Stack woke in his home in the quiet, leafy neighborhood of North Austin, Texas. A self-employed software consultant and a part-time bassist in a local band, Joe, as his friends called him, started the day by setting fire to his house.


pages: 402 words: 110,972

Nerds on Wall Street: Math, Machines and Wired Markets by David J. Leinweber

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AI winter, algorithmic trading, asset allocation, banking crisis, barriers to entry, Big bang: deregulation of the City of London, butterfly effect, buttonwood tree, buy low sell high, capital asset pricing model, citizen journalism, collateralized debt obligation, corporate governance, Craig Reynolds: boids flock, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Danny Hillis, demand response, disintermediation, distributed generation, diversification, diversified portfolio, Emanuel Derman, en.wikipedia.org, experimental economics, financial innovation, Gordon Gekko, implied volatility, index arbitrage, index fund, information retrieval, Internet Archive, John Nash: game theory, Khan Academy, load shedding, Long Term Capital Management, Machine translation of "The spirit is willing, but the flesh is weak." to Russian and back, market fragmentation, market microstructure, Mars Rover, moral hazard, mutually assured destruction, natural language processing, Network effects, optical character recognition, paper trading, passive investing, pez dispenser, phenotype, prediction markets, quantitative hedge fund, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Renaissance Technologies, Richard Stallman, risk tolerance, risk-adjusted returns, risk/return, Ronald Reagan, semantic web, Sharpe ratio, short selling, Silicon Valley, Small Order Execution System, smart grid, smart meter, social web, South Sea Bubble, statistical arbitrage, statistical model, Steve Jobs, Steven Levy, Tacoma Narrows Bridge, the scientific method, The Wisdom of Crowds, time value of money, too big to fail, transaction costs, Turing machine, Upton Sinclair, value at risk, Vernor Vinge, yield curve, Yogi Berra

Unfortunately, these solutions ignore the fact that every relevant institution is in survival mode and will only use any liquidity or capital injections as a cushion in case their sources of funding dry up or their assets have to be further written down (very likely considering where we are in the economic cycle). Even worse, they all involve some type of moral hazard by cushioning the losses for equity and unsecured debt holders (who are to varying degrees responsible for the crisis). The recent reports of capital injections effectively being used for dividends and deferred compensation are perhaps the most heinous examples of taxpayer funds being used to directly pay existing equity holders and management. Here we briefly evaluate each of the bailout variations so far, their intended effect, why they are unlikely to work, and why they will probably lead to an extension of the crisis. Finally, we propose an alternate plan based on capitalizing new banks with clean balance sheets and discuss its potential effects. * Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk.

. • Creation of even more complex, more incomprehensible pricing models, driven by the wrong data. Shooting the Moon 299 Wildly Complex Derivatives Traded on Analyzed with Utterly Opaque Markets Even More Complex Pricing Models Lack of Market Prices Create Need for Driven by Carelessly Inappropriate Data Figure 12.10 An interconnected structure for disaster: uses and abuses of technology in bringing on the Great Mess of ’08. There are many other causes, over-leverage, moral hazard (“heads, I win, tails, you lose”), and heads in the sand. These are the ones that involve wires. Figure 12.10 shows the vicious circle of financial technology errors that contributed to our sorry situation today—the design of monstrously complex incomprehensible derivatives, which then required monstrously complex valuation models, since there was no transparent market to provide this information.

These new banks would then acquire the operational and human capital assets of failed banks in Federal Deposit Insurance Corporation (FDIC) receivership. New structural flaws in the government’s rescue plans are revealed on an almost daily basis. The incentives for these plans to work to the 312 Nerds on Wall Str eet benefit of the country, and not the failed firms, are poorly aligned. The new American bank initiative (NABI) would involve no moral hazard,* no hoarding banks, no government ownership, and no throwing good money after bad. Most important, it will immediately provide $7 trillion or more in unencumbered lending capacity to real projects—green energy, infrastructure, and auto and other manufacturing. It is also the best plan for preserving the operational and human assets of failed banks and saving existing solvent institutions by making everyone confident in the availability of funds again.


pages: 350 words: 109,220

In FED We Trust: Ben Bernanke's War on the Great Panic by David Wessel

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Asian financial crisis, asset-backed security, bank run, banking crisis, banks create money, Berlin Wall, Black Swan, central bank independence, credit crunch, Credit Default Swap, crony capitalism, debt deflation, Fall of the Berlin Wall, financial innovation, financial intermediation, full employment, George Akerlof, housing crisis, inflation targeting, London Interbank Offered Rate, Long Term Capital Management, market bubble, moral hazard, mortgage debt, new economy, Northern Rock, price stability, quantitative easing, Robert Shiller, Robert Shiller, Ronald Reagan, Saturday Night Live, savings glut, Socratic dialogue, too big to fail

Well before the Lehman debacle, Taylor — who was big on making rules that guided policy — attacked Bernanke, Geithner, and Paulson for failing to explain to the markets and the public the criteria for rescuing Bear Stearns so everyone would know how the same trio planned to respond the next time a big financial house got into trouble. Most inside the Fed, though, swallowed hard and concluded Bernanke and Geithner had made the best battlefield decision possible. “There is no question we created moral hazard by doing this. But there are moral hazard extremists who think moral hazard is such a big problem that we should never do anything that creates it,” Mishkin said after returning to Columbia University’s business school. “It is unfortunate that we didn’t have more time to think about this, but the risk is that you may go into a depression if you screw it up.” In early April, Bernanke, Geithner, the SEC’s Cox, and Treasury’s Steel were called before the Senate Banking Committee.

Three months after Bear Stearns, the Richmond Fed president, Jeffrey Lacker, made headlines with a denunciation of the Bernanke-Geithner rescue in a speech in London. The Fed should always move to stop irrational runs on the banks, the self-perpetuating kind where panic by some bank depositors leads to panic by many, Lacker said. But by preventing Bear Stearns from failing, the Fed was sowing the seeds of future crises. It was creating “moral hazard,” a term borrowed from the insurance business to describe the temptation to take bigger risks because someone else will pay the cost if things go wrong. Like Lacker, Philadelphia’s Charles Plosser and a few other Fed officials saw the Bear Stearns rescue as the original sin that led to the risk taking that worsened the turmoil that would follow later: the Fed, they argued, had led markets, executives, and creditors of big financial institutions to take unwise risks with the understanding that they expected the Fed to step in if anything bad happened.

Meltzer, “Keep the Fed Away from Investment Bank,” Wall Street Journal, July 16, 2008, A17. 157 The SEC was legally: Kara Scannell and Susanne Craig, “SEC Chief under Fire as Fed Seeks Bigger Wall Street Role — Cox Draws Criticism for Low-Key Leadership during Bear Crisis,” Wall Street Journal, June 23, 2008, A1. 158 “We’ve got to make” Greg Ip, “Crisis Management: Fed’s Fireman on Wall Street Feels Some Heat,” Wall Street Journal, May 30, 2008, A1. 158 “Things happened very quickly” Senate Banking Committee, hearing, April 3, 2008. 159 “Everybody on the phone” Interview, Donald Kohn. 159 Bear Stearns had: Harvey Rosenbloom, et al., “Fed Interview: Managing Moral Hazard in Financial Crisis,” Economic Letter, Federal Reserve Bank of Dallas, October 2008. 160 “a gigantic centralization” Herbert Hoover, “Herbert Hoover: 1932-33,” from the Public Papers of the Presidents of the United States Web site, 1932, 308. http://quod.lib.umich.edu/cgi/t/text/pageviewer-idx? c=ppotpus;cc=ppotpus;rgn=full%20text; idno=4731694.1932.001;didno=4731694.1932.001; view=image;seq=00000364 160 After the 1932 law passed: Howard H.


pages: 370 words: 112,602

Poor Economics: A Radical Rethinking of the Way to Fight Global Poverty by Abhijit Banerjee, Esther Duflo

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Albert Einstein, Andrei Shleifer, business process, business process outsourcing, call centre, Cass Sunstein, charter city, clean water, collapse of Lehman Brothers, congestion charging, demographic transition, diversified portfolio, experimental subject, hiring and firing, land tenure, low skilled workers, M-Pesa, microcredit, moral hazard, purchasing power parity, randomized controlled trial, Richard Thaler, school vouchers, Silicon Valley, The Fortune at the Bottom of the Pyramid, Thomas Malthus, urban planning

She seemed to think it was normal that no one would offer to help out with her health expenses. What stops people from doing more to help one another? Why are some forms of risk not covered, or not covered well? There are good reasons we may be unwilling to offer unconditional help to our friends and neighbors. For one thing, we may worry that the guarantee of help might create a temptation to slack off—this is what insurers call moral hazard. Or that people may claim that they are in need even when they are not. Or simply that the promise of mutual help may not be carried through: I help you, but when your turn comes around, you are too busy. These are all explanations for why we may want to hold back our help a little, but it is not clear whether this could explain not offering help to those who just became very sick, because falling ill is presumably not a choice.

All that seems to be lacking is someone to organize this market: This has prompted international organizations (such as the World Bank) and large foundations (likes the Gates Foundation) to invest hundreds of millions of dollars to encourage the development of insurance options for the poor. There are of course a number of obvious difficulties with providing insurance. These problems are not specific to the poor. They are fundamental problems, but they are amplified in poor countries, where it is more difficult to regulate insurers and monitor the insured. We have already mentioned “moral hazard”: People may change their behavior (farm less carefully, spend more money on health care, and so forth) once they know that they will not bear the full consequences. Consider some of the problems of providing health insurance, for example. We have seen that even without health insurance, the poor visit some forms of health providers all the time. What will they do if visits become free? And won’t the doctors also have reason to prescribe unnecessary tests and drugs, especially if they also own a lab (which a lot of doctors do, both in the United States and in India) or get kickbacks from the drugstore?

Consider weather, for example. A farmer should value a policy that pays him a fixed amount (based on the premium he paid) when the rainfall measured at the nearby weather station falls below a certain critical level. Because no one controls the weather and there is no judgment to be made about what should be done (unlike in medical care, where someone must decide which tests or treatment is needed), there is no scope for moral hazard or fraud. Within health care, insuring catastrophic health events—major illnesses, accidents—seems much easier than covering outpatient care. Nobody wants to have surgery or chemotherapy just for the heck of it, and the treatment is easily verified. The danger of overtreatment remains, but the insurer can cap what it will pay for each treatment. The big issue that remains is selection: The insurance company does not want only sick people signing up.


pages: 276 words: 82,603

Birth of the Euro by Otmar Issing

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accounting loophole / creative accounting, Bretton Woods, business climate, capital controls, central bank independence, currency peg, financial innovation, floating exchange rates, full employment, inflation targeting, labour market flexibility, labour mobility, market fundamentalism, moral hazard, oil shock, open economy, price anchoring, price stability, purchasing power parity, reserve currency, Y2K, yield curve

In a single currency area, the political benefit from deficit spending (gaining votes) is enjoyed by national players, while the potential negative effects in the form of higher interest rates (due to increased government borrowing) are felt by all member states. Thus the resistance to deficit spending is reduced, and the propensity to pursue an (inappropriate) expansionary fiscal policy increases – a typical case of what is known as moral hazard. In the consultations on the constitution for the future monetary union, this problem could not be disregarded. On the one hand, a ‘European government’ with corresponding powers was not an option. The national governments (and parliaments) would basically retain their fiscal policy sovereignty. On the other hand, moral 194 • The central bank and monetary policy in EMU hazard and the danger of individual member states acting in a way that was detrimental to stability had to be avoided if the success of monetary union was not to be put at risk from the outset.

This in turn supports expectations of macroeconomic stability and makes the task of the single monetary policy oriented towards maintaining price stability easier. 14 See ECB, ‘Fiscal policies and financial markets’, Monthly Bulletin, February 2006. 196 • The central bank and monetary policy in EMU 2. The rules must lead to sustainable budget policies in the member states and offer protection against moral hazard. As the sanction imposed by the market (interest rates) is insufficient, precautions must be taken so that the case of sovereign insolvency due to over-indebtedness never arises and the no-bail-out principle is never put to the test. 3. While committing governments to a sound budget policy, the rules must also strengthen the incentives for structural reforms to promote employment and growth. 4.

Not only is this impeded by the need to agree on the position with the national government and obtain the approval of parliament, but – depending on the situation – there may be strong political incentives to renege on a commitment previously entered into in the framework of coordination. This risk would always arise, for example, if the central bank, counting on a restrictive fiscal policy stance, committed itself to an expansionary monetary policy. Even if some governments kept their ‘promises’, it would be most unlikely that all governments (and parliaments) would do so. There would, at any rate, be a high risk of moral hazard. To judge from the experience with the Stability and Growth Pact, it would most certainly be unwise to subject the ECB’s monetary policy to such ‘tests’. In the end, monetary policy would be blamed for having sacrificed its own objective of price stability to the interests of the other stakeholders. There would be much too great a risk of the central bank losing credibility. The same objections can be raised against the proposal to create a ‘European economic government’ as a ‘counterpart’ or ‘counterweight’ to the ECB, as called for not least in the 2007 presidential campaign in France, and as reiterated by the winning candidate.


pages: 261 words: 86,905

How to Speak Money: What the Money People Say--And What It Really Means by John Lanchester

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asset allocation, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Swan, blood diamonds, Bretton Woods, BRICs, Capital in the Twenty-First Century by Thomas Piketty, Celtic Tiger, central bank independence, collapse of Lehman Brothers, collective bargaining, credit crunch, Credit Default Swap, crony capitalism, Dava Sobel, David Graeber, disintermediation, double entry bookkeeping, en.wikipedia.org, estate planning, financial innovation, Flash crash, forward guidance, Gini coefficient, global reserve currency, high net worth, High speed trading, hindsight bias, income inequality, inflation targeting, interest rate swap, Isaac Newton, Jaron Lanier, joint-stock company, joint-stock limited liability company, Kodak vs Instagram, liquidity trap, London Interbank Offered Rate, London Whale, loss aversion, margin call, McJob, means of production, microcredit, money: store of value / unit of account / medium of exchange, moral hazard, neoliberal agenda, New Urbanism, Nick Leeson, Nikolai Kondratiev, Nixon shock, Northern Rock, offshore financial centre, oil shock, open economy, paradox of thrift, Plutocrats, plutocrats, Ponzi scheme, purchasing power parity, pushing on a string, quantitative easing, random walk, rent-seeking, reserve currency, Richard Feynman, Richard Feynman, road to serfdom, Ronald Reagan, Satoshi Nakamoto, security theater, shareholder value, Silicon Valley, six sigma, South Sea Bubble, sovereign wealth fund, Steve Jobs, The Chicago School, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, trickle-down economics, Washington Consensus, working poor, yield curve

At the moment monopoly power is growing on both sides of the Atlantic. We know that for sure because of the Herfindahl-Hirschman index, a rather groovy way of putting a numerical value on the concentration of monopoly power. moral hazard A term most people had never heard before the financial crisis of 2008, but it was used so often during the crisis that we all got sick of it. There is moral hazard when there is an economic structure that does not penalize, and at worst actively encourages, reckless behavior. Bailing out the banks, for instance, creates a classic form of moral hazard, because it exempts those banks from the consequences of their mistakes. Perhaps the most spectacular example during the credit crunch was the bailout/nationalization of AIG, the company that had insured most of the world’s credit default swaps, and as a result was on the brink of going broke.

Perhaps the most spectacular example during the credit crunch was the bailout/nationalization of AIG, the company that had insured most of the world’s credit default swaps, and as a result was on the brink of going broke. Banks had taken out insurance with AIG, and there was a case to be made for punishing them for being so stupid. Instead AIG got its bailout, which mainly involved direct transfers of cash to the banks that were its counterparties. The banks suffered no consequences for their mistakes, and so had no incentives to avoid such mistakes in the future—a textbook example of moral hazard. It was worry about moral hazard that made the Bank of England slow to act when the first signs of the credit crunch appeared with the collapse of the bank Northern Rock in autumn 2007. The term is close to being an example of reversification, but perhaps it’s more like a simple obfuscation: what we’re really talking about is the bad guys getting away with it. mortgage The word literally means “dead pledge,” and if it were called that maybe more people would think twice about getting one.


pages: 267 words: 71,123

End This Depression Now! by Paul Krugman

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airline deregulation, Asian financial crisis, asset-backed security, bank run, banking crisis, Bretton Woods, capital asset pricing model, Carmen Reinhart, centre right, correlation does not imply causation, credit crunch, Credit Default Swap, currency manipulation / currency intervention, debt deflation, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, Financial Instability Hypothesis, full employment, German hyperinflation, Gordon Gekko, Hyman Minsky, income inequality, inflation targeting, invisible hand, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, labour mobility, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, Long Term Capital Management, low skilled workers, Mark Zuckerberg, moral hazard, mortgage debt, paradox of thrift, price stability, quantitative easing, rent-seeking, Robert Gordon, Ronald Reagan, Upton Sinclair, We are the 99%, working poor, Works Progress Administration

If you’ve ever seen the movie It’s a Wonderful Life, which features a run on Jimmy Stewart’s bank, you might be interested to know that the scene is completely anachronistic: by the time the supposed bank run takes place, that is, just after World War II, deposits were already insured, and old-fashioned bank runs were things of the past. On the other side, Glass-Steagall limited the amount of risk banks could take. This was especially necessary given the establishment of deposit insurance, which could have created enormous “moral hazard.” That is, it could have created a situation in which bankers could raise lots of money, no questions asked—hey, it’s all government-insured—then put that money into high-risk, high-stakes investments, figuring that it was heads they win, tails taxpayers lose. One of the first of many deregulatory disasters came in the 1980s, when savings and loan institutions demonstrated, with a vengeance, that this kind of taxpayer-subsidized gambling was more than a theoretical possibility.

At that signing ceremony, Reagan explained how it was supposed to work: What this legislation does is expand the powers of thrift institutions by permitting the industry to make commercial loans and increase their consumer lending. It reduces their exposure to changes in the housing market and in interest rate levels. This in turn will make the thrift industry a stronger, more effective force in financing housing for millions of Americans in the years to come. But it didn’t work out that way. What happened instead was that deregulation created a classic case of moral hazard, in which the owners of thrifts had every incentive to engage in highly risky behavior. After all, depositors didn’t care what their bank did; they were insured against losses. So the smart move for a banker was to make high-interest-rate loans to dubious borrowers, typically real estate developers. If things went well, the bank would register large profits. If they went badly, the banker could just walk away.

academic sociology, 92, 96, 103 AIG, 55 airlines, deregulation of, 61 Alesina, Alberto, 196–99 American Airlines, 127 American Recovery and Reinvestment Act (ARRA): cost of, 121 inadequacy of, 108, 109–10, 116–19, 122–26, 130–31, 212, 213 Angle, Sharron, 6 anti-Keynesians, 26, 93–96, 102–3, 106–8, 110–11, 192 Ardagna, Silvia, 197–99 Argentina, 171 Arizona, housing bubble in, 111 Asian financial crisis of 1997–98, 91 asset-backed securities, 54, 55 auction rate securities, 63 Austerians, 188–207 creditors’ interests favored by, 206–7 supposed empirical evidence of, 196–99 austerity programs: alarmists and, 191–95, 224 arguments for, 191–99 economic contraction and, 237–38 in European debt crisis, 46, 144, 185, 186, 188 as ineffective in depressions, xi, 213 state and local governments and, 213–14, 220 unemployment and, xi, 189, 203–4, 207, 237–38 Austrian economics, 150 automobile sales, 47 babysitting co-op, 26–28, 29–30, 32–33, 34 Bakija, Jon, 78 balance of trade, 28 Ball, Laurence, 218 Bank for International Settlements (BIS), 190, 191 Bank of England, 59 Bank of Japan, 216, 218 bankruptcies, personal, 84 bankruptcy, 126–27 Chapter 11, 127 banks, banking industry: capital ratios in, 58–59 complacency in, 55 definition of, 62 deregulation of, see deregulation, financial European, bailouts of, 176 government debt and, 45 “haircuts” in, 114–15 incomes in, 79–80 lending by, 30 money supply and, 32 moral hazard in, 60, 68 1930s failures in, 56 origins of, 56–57 panics in, 4, 59 political influence of, 63 receivership in, 116 regulation of, 55–56, 59–60, 100 repo in, 62 reserves in, 151, 155, 156 revolving door in, 86, 87–88 risk taking in, see risk taking runs on, 57–58, 59, 60, 114–15, 155 separation of commercial and investment banks in, 60, 62, 63 shadow, 63, 111, 114–15 unregulated innovations in, 54–55, 62–63, 83 Barro, Robert, 106–7 Bebchuck, Lucian, 81 Being There (film), 3 Bernanke, Ben, 5, 10–11, 32, 76, 104, 106, 151, 157, 159–60, 210 recovery and, 216–19 on 2008–09 crisis, 3–4 “Bernanke Must End Era of Ultra-low Rates” (Rajan), 203–4 Black, Duncan, 190 Blanchard, Olivier, 161–63 Bloomberg, Michael, 64 BNP Paribas, 113 Boehner, John, 28 bond markets: interest rates in, 132–41, 133 investor confidence and, 132, 213 bonds, high-yield (junk bonds), 115, 115 bond vigilantes, 125, 132–34, 138, 139, 140 Bowles, Erskine, 192–93 Brazil, 171 breach of trust, 80 Bretton Woods, N.H., 41 Broder, David, 201 Brüning, Heinrich, 19 Buckley, William F., 93 Bureau of Labor Statistics, U.S.


pages: 193 words: 11,060

Ethics in Investment Banking by John N. Reynolds, Edmund Newell

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accounting loophole / creative accounting, banking crisis, capital controls, collapse of Lehman Brothers, corporate governance, corporate social responsibility, credit crunch, Credit Default Swap, discounted cash flows, financial independence, index fund, invisible hand, margin call, moral hazard, Nick Leeson, Northern Rock, quantitative easing, shareholder value, short selling, South Sea Bubble, stem cell, the market place, The Wealth of Nations by Adam Smith, too big to fail

Calculated as the discount rate that makes the net present value of all future cash flows zero Investment banking: providing specialist investment banking services, including capital markets activities and M&A advice, to large clients (corporations and institutional investors) Glossary xi Investment banking adviser: see Adviser Islamic banking: banking structured to comply with Shariah (Islamic) law Junior debt: debt that is subordinated or has a lower priority than other debt Junk bond: see High yield bond Lenders: providers of debt finance Leverage: debt Leveraged acquisition: acquisition of a company using high levels of debt to finance the acquisition LIBOR: London Inter-Bank Offered Rate, the rate at which banks borrow from other banks Liquidity: capital required to enable trading in capital markets M&A: mergers and acquisitions; typically the major advisory department in an investment bank Market abuse: activities that undermine efficient markets and are proscribed under legislation Market capitalism: a system of free trade in which prices are set by supply and demand (and not by the Government) Market maker: a market participant who offers prices at which it will buy and sell securities Mis-selling: inaccurately describing securities (or other products) that are being sold Moral hazard: the risk that an action will result in another party behaving recklessly Moral relativism: the concept that morals and ethics are not absolute, and can vary between individuals Multi-notch downgrade: a significant downgrade in rating or recommendation (by a rating agency) Natural law: the concept that there is a universal moral code Net assets: calculated as total assets minus total liabilities Net present value (NPV): sum of a series of cash inflows and outflows discounted by the return that could have been earned on them had they been invested today NYSE: New York Stock Exchange Operating profit: calculated as revenue from operations minus costs from operations P:E: ratio used to value a company where P (Price) is share price and E (Earnings) is earnings per share Price tension: an increase in sales price of an asset, securities or a business resulting from a competitive situation in an auction xii Glossary Principal: equity investor in a transaction Principal investment: proprietary investment Private equity: equity investment in a private company Private equity fund: investment funds that invest in private companies Proprietary investment: an investment bank’s investment of its own capital in a transaction or in securities Qualifying instruments: securities covered by legislation Qualifying markets: capital markets covered by legislation Quantitative easing: Government putting money into the banking system to increase reserves Regulation: legal governance framework imposed by legislation Restructuring: investment banking advice on the financial restructuring of a company unable to meet its (financial) liabilities Returns: profits Rights-based ethics: ethical values based on the rights of an individual, or an organisation SEC: the Securities and Exchange Commission, a US regulatory authority Sarbanes–Oxley: the US “Company Accounting Reform and Investor Protection Act” Senior debt: debt that takes priority over all other debt and that must be paid back first in the event of a bankruptcy Shariah finance: financing structured in accordance with Shariah or Islamic law Sovereign debt: debt issued by a Government Speculation: investment that resembles gambling; alternatively, very short-term investment without seeking to gain management control Socially responsible investing (SRI): an approach to investment that aims to reflect and/or promote ethical principles Spread: the difference between the purchase (bid) and selling (offer) price of a security Subordinated debt: see Junior debt Syndicate: group of banks or investment banks participating in a securities issue Syndication: the process of a group of banks or investment banks selling a securities issue Takeover Panel: UK authority overseeing acquisitions of UK public companies Too big to fail: the concept that some companies or sectors are too large for the Government to allow them to become insolvent Glossary xiii Unauthorised trading: trading on behalf of an investment bank or other investor without proper authorisation Universal bank: an integrated bank Utilitarian: ethical values based on the end result of actions, also referred to as consequentialist Volcker Rule: part of the Dodd–Frank Act, restricting the proprietary investment activities of deposit-taking institutions Write-off: reduction in the value of an investment or loan Zakat: charitable giving, one of the five pillars of Islam This page intentionally left blank 1 Introduction: Learning from Failure There has been significant criticism of the ethics of the investment banking sector following the financial crisis.

A comparison cannot be drawn on the grounds of protected revenue or lack of competition between utilities and investment banking, where revenue is not protected and there are no natural monopoly characteristics. The UK’s Independent Commission on Banking stated that too big to fail “constitutes a perceived acceptance of risk by the state . . . . with the potential for the related rewards to be enjoyed by the private sector”. This is described, in their Call for Evidence, as “inequitable” and “creating moral hazard incentives for poor decision making”.6 Ethical duties and the implicit Government guarantee The duty that investment banks owe to their Governments is affected by the implicit guarantee from Governments to support the financial markets. Investment banks have benefitted from this during the financial crisis – the liquidity crisis in the markets would have brought markets to some form of collapse without Government intervention.

Consequently, while markets can be “efficient” and it is understood that all participants are seeking to profit, there can also be unequal economic outcomes to market activity (one counterparty may profit and another lose from a trade). Preventing outcomes where some participants incur losses may be an attractive ideal, but it is not practical and not ethically required. It also gives rise to moral hazards. If an investment bank is by its nature a market counterparty, and is expected by its customers and the market operators to take risks, it is difficult to expect the investment bank to behave towards all market counterparties as if they are clients, and to act so as to always protect its counterparties’ interests. However, where an investment bank is selling securities, either for commission to existing clients or to non-commissionpaying customers, the investment bank would be expected to deal fairly, The Two Opposing Views of Investment Banking Ethics: Rights vs Duties 71 and to make appropriate disclosure, so that its products can be understood and therefore valued properly.


pages: 206 words: 70,924

The Rise of the Quants: Marschak, Sharpe, Black, Scholes and Merton by Colin Read

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Albert Einstein, Black-Scholes formula, Bretton Woods, Brownian motion, capital asset pricing model, collateralized debt obligation, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, discovery of penicillin, discrete time, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, floating exchange rates, full employment, Henri Poincaré, implied volatility, index fund, Isaac Newton, John von Neumann, Joseph Schumpeter, Long Term Capital Management, Louis Bachelier, margin call, market clearing, martingale, means of production, moral hazard, naked short selling, price stability, principal–agent problem, quantitative trading / quantitative finance, RAND corporation, random walk, risk tolerance, risk/return, Ronald Reagan, shareholder value, Sharpe ratio, short selling, stochastic process, The Chicago School, the scientific method, too big to fail, transaction costs, tulip mania, Works Progress Administration, yield curve

To prevent the bankruptcy of one of the largest companies in the country, the US government supplied $182.5 billion in credit to the company in what constituted, at the time, the largest corporate bailout in history.1 Of course, the danger of privatized profits but socialized losses in insurable activities is the moral hazard problem. The Black-Scholes equation assumes that the random walk of log-normal values follows a log-normal distribution. This is a symmetric distribution, and assumes that upside and downside risk are equally likely consequences of external forces. When the insured entity can affect the risk profile and hence increase its probability of crossing the exercise threshold, the Black-Scholes estimate of efficient options pricing is biased. In essence, the insured can purchase the option too cheaply, or, in the case of moral hazard, exhibit insufficient prudence because of the protection of insurance. Given the extreme leverage and the dependence on the Black-Scholes equation for pricing, options markets are particularly susceptible to market manipulation and the resulting distortions of the assumption of a log-normal distribution of returns that are assumed to be independent over time.

In an era of investment banks too big to be allowed to fail, if a market suddenly seizes and prevents investors from unwinding, they may find themselves owing hundreds of billions of dollars, as AIG had discovered. In such a case, in which companies keep their profits in good times but must be bailed out to prevent even greater financial catastrophe in bad times, the financial system creates the moral hazard problem of privatized gains and socialized losses. Scholes agreed that the reality in which finance found itself by 2007 was problematic. Scholes proposed that the financial system should be deleveraged. However, he acknowledged the difficulty of such a proposal. If investors must establish a safer balance between assets controlled and the capital invested, then a large portion of their securities assets would have to be sold.

During the unwinding of Long Term Capital Management, the New York Fed was involved in its first huge financial company bailout of a financial company deemed too big to fail. It would not be its last. At the time, as in the aftermath of even larger bailouts in 2008 and 2009, some expressed grave concern that to bail out firms deemed too big to fail encouraged similarly positioned firms to take inordinate risks. Suddenly, the insurance concept of moral hazard had entered the finance lexicon. In the aftermath, executives of related companies were forced to resign by their boards. Goldman Sachs CEO Jon Corzine was ousted in a board-level effort organized by future Treasury Secretary Henry Paulson. Corzine went into politics and represented New Jersey in the US Senate, then led the large investment bank MF Global to its dramatic demise as it illegally comingled its customer’s funds with its proprietary investment fund and lost hundreds of millions of dollars.


pages: 318 words: 77,223

The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse by Mohamed A. El-Erian

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Airbnb, balance sheet recession, bank run, barriers to entry, Bretton Woods, British Empire, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, carried interest, collapse of Lehman Brothers, corporate governance, currency peg, Erik Brynjolfsson, eurozone crisis, financial innovation, Financial Instability Hypothesis, financial intermediation, financial repression, Flash crash, forward guidance, friendly fire, full employment, future of work, Hyman Minsky, If something cannot go on forever, it will stop, income inequality, inflation targeting, Jeff Bezos, Kenneth Rogoff, Khan Academy, liquidity trap, Martin Wolf, megacity, Mexican peso crisis / tequila crisis, moral hazard, mortgage debt, oil shale / tar sands, price stability, principal–agent problem, quantitative easing, risk tolerance, risk-adjusted returns, risk/return, Second Machine Age, secular stagnation, sharing economy, sovereign wealth fund, The Great Moderation, The Wisdom of Crowds, too big to fail, University of East Anglia, yield curve

Unlike the ECB’s emergency response seven months earlier involving liquidity injections, the Fed’s intervention made broader use of the public balance sheet. Importantly, it provided financial (loss-protected) backing for a shotgun wedding between failing Bear Stearns and solid-standing JPMorgan Chase. Central banks’ hope was that these two very sudden and disturbing shocks, together with the exceptional nature of the policy response, would entice banks to de-risk in an orderly manner. Instead, banks seemed beholden to what economists call “moral hazard”—that is, the inclination to take more risk because of the perceived backing of an effective and decisive insurance mechanism. There is perhaps no better example of this phenomenon than what Chuck Prince, the then CEO of Citigroup, one of the biggest and most closely followed banks in the world, told the Financial Times in a front-page interview. Commenting on the prospects for problems down the road, he stated: “When the music stops, in terms of liquidity things will be complicated.

“Rational bubble riding” became acceptable, and the incentive to do so was turbocharged by an industry that has become more short-term focused in assessing both absolute and relative performance, and in which capital can move quite quickly given that few end investors are willing to revise down their return expectations. To some, the behavior of financial markets once again showed insufficient heed paid to the important insights of Hyman Minsky, the American economist. Known for his “financial instability hypothesis,”7 Minsky argued that, in capitalist economies, periods of financial stability give rise to subsequent periods of great financial instability. The extent of underlying moral hazard became more and more notable. I remember being bemused in October 2014 by the extent to which the return of some modest market volatility caused some respected market participants to call for the Fed to come up with “QE4”—that is, yet another program of large-scale asset purchases in order to repress market volatility and artificially boost asset prices again. To be clear, this was a period during which U.S. growth was picking up and (very slowly) becoming somewhat less skewed to favor the better-off; the economy was on an impressive run of producing 200,000-plus jobs each month (one that lasted more than twelve consecutive months).

But it’s a complicated argument to make and I don’t think we always made it as well as we could have.”2 Former secretary Geithner went further. Recognizing the difficulty of selling to the public the case for bailouts, he reacted quite sharply to those who suggested that such assistance to banks would encourage renewed irresponsible behavior down the road. He saw little merit for the claims of those he labeled in his book “moral hazard fundamentalists.”3 Recognizing the continued anger in the country, an active group of politicians is interested not only in de-risking the banks further but also in gaining greater insights into how their de facto main supervisor, the Federal Reserve, operates—so much so as to push an inherently nonconfrontational Chair Yellen to warn in July 2014 congressional testimony that greater Fed oversight could be a “grave mistake.”4 Yet this phenomenon will not dissipate anytime soon, especially as it unites lawmakers on both sides of the political aisle, albeit for different reasons.


pages: 543 words: 157,991

All the Devils Are Here by Bethany McLean

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Asian financial crisis, asset-backed security, bank run, Black-Scholes formula, call centre, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Exxon Valdez, fear of failure, financial innovation, fixed income, high net worth, Home mortgage interest deduction, interest rate swap, laissez-faire capitalism, Long Term Capital Management, margin call, market bubble, market fundamentalism, Maui Hawaii, moral hazard, mortgage debt, Northern Rock, Own Your Own Home, Ponzi scheme, quantitative trading / quantitative finance, race to the bottom, risk/return, Ronald Reagan, Rosa Parks, shareholder value, short selling, South Sea Bubble, statistical model, telemarketer, too big to fail, value at risk

Within the administration, Summers invariably took the Greenspan position that the market was better equipped to recognize and handle risk than Washington regulators. And, like Greenspan, Summers’s belief that the market cured all problems blinded him to the systemic risks that were building up. But he could see all too clearly the risks posed by Fannie and Freddie. For officials like Greenspan and Summers, there was something offensive about the GSEs. The moral hazard that existed in the banking system—and that would be all too obvious during the financial crisis—was something policy makers couldn’t see. But the moral hazard posed by Fannie and Freddie? That they could see plain as day. In late 1999, Summers made a speech at a Women in Housing & Finance conference, which included one sentence about Fannie and Freddie: “Debates about systemic risk should also now include government-sponsored enterprises, which are large and growing rapidly.”

Yes, they were flawed institutions that were far too big and, quite possibly, posed systemic risk. But Paulson was a pragmatist. He dealt with things as they were. Fannie and Freddie weren’t going away; they were a problem that needed to be managed. Besides, the GSEs were only partly to blame for the monsters they’d become. “This was created by Congress,” he’d say. When he did focus on Fannie and Freddie, he didn’t gnash his teeth at the moral hazard they posed. Rather, he worked to reduce that moral hazard. One step was to get Fannie and Freddie a new regulator. It was no secret that OFHEO was outmatched; practically from the moment he was named Treasury secretary, Paulson had worked to push through legislation to create a new regulator that would have real authority to set capital requirements, conduct serious audits, and even—if it came to that—wind down the GSEs.

In his book, Paulson describes the new price as “an unseemly precedent to reward the shareholders of a firm that had been bailed out by the government.” And it had, because J.P. Morgan would not have done the deal if the Fed hadn’t agreed to provide a $30 billion loan to a stand-alone entity that would buy a pool of Bear’s mortgages that J.P. Morgan didn’t want. The banks’ dirty little secret was now out in the open. It wasn’t just Fannie and Freddie that had been creating moral hazard all these years. So had the nation’s big banks. They had taken on terrible risks, built up immense leverage, and created such tight interconnections with their derivatives books that the failure of any one of them could bring down all the others. When things got bad, they assumed they had an “implicit government guarantee,” just like Fannie and Freddie. In On the Brink, Paulson recalls a phone call he received from his former number two at Goldman, Lloyd Blankfein.


pages: 524 words: 143,993

The Shifts and the Shocks: What We've Learned--And Have Still to Learn--From the Financial Crisis by Martin Wolf

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air freight, anti-communist, Asian financial crisis, asset allocation, asset-backed security, balance sheet recession, bank run, banking crisis, banks create money, Basel III, Ben Bernanke: helicopter money, Berlin Wall, Black Swan, bonus culture, Bretton Woods, call centre, capital asset pricing model, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, debt deflation, deglobalization, Deng Xiaoping, diversification, double entry bookkeeping, en.wikipedia.org, Erik Brynjolfsson, Eugene Fama: efficient market hypothesis, eurozone crisis, Fall of the Berlin Wall, fiat currency, financial deregulation, financial innovation, financial repression, floating exchange rates, forward guidance, Fractional reserve banking, full employment, global rebalancing, global reserve currency, Growth in a Time of Debt, Hyman Minsky, income inequality, inflation targeting, invisible hand, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, labour mobility, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, Long Term Capital Management, margin call, market bubble, market clearing, market fragmentation, Martin Wolf, Mexican peso crisis / tequila crisis, moral hazard, mortgage debt, new economy, North Sea oil, Northern Rock, open economy, paradox of thrift, price stability, private sector deleveraging, purchasing power parity, pushing on a string, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, reserve currency, Richard Feynman, Richard Feynman, risk-adjusted returns, risk/return, road to serfdom, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, Second Machine Age, secular stagnation, shareholder value, short selling, sovereign wealth fund, special drawing rights, The Chicago School, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, too big to fail, Tyler Cowen: Great Stagnation, very high income, winner-take-all economy

The solution to the Eurozone crisis from the German perspective, then, is to impose these principles throughout the Eurozone. That explains the emphasis on rule-making. It also explains the emphasis on austerity and structural reform. In the German view, this is a long game. Germany believes in tough love. This is also partly because it has been consistently fearful of ‘moral hazard’ in international lending. The idea of ‘moral hazard’ is that providing generous and, above all, unconditional insurance against mishap encourages unduly risky behaviour. These concerns about incentives provided by insurance are legitimate: it is why insurance contracts include deductibles payable by the insured. In the end, Germany has shown itself willing to provide conditional and limited support, but only if vulnerable member states are prepared to toe their line: those then are the conditions that accompany the insurance.

Indeed, the complacency it induced in the form of the idea of the great moderation played a big role in causing the crisis. Crisis Intervention The final question concerns how the policymakers responded to the crisis when it hit. In the panic, they were caught between two opposing pressures: the first was the view that those who made mistakes should be allowed to fail, to minimize ‘moral hazard’ (the risk that insurance makes the insured take greater risks); the second was the need to respond to a panic. The concern about moral hazard is greatly exaggerated. Nobody argues there should be no fire service because the knowledge that it exists encourages people to take the risk of smoking in bed. We have fire brigades mainly because of the spillover impact on innocent people: if someone’s house burns down, we may end up with the Great Fire of London, as happened in 1666.

Were the mistakes in handling the crisis, as some argue, even more important than those made before the crisis? All these views turn out to be partially correct. The chapter will analyse what makes financial systems inherently fragile. It will then look closely at what made the financial system particularly fragile, prior to 2007. It will examine the growth of ‘shadow banking’, the increase in financial complexity and interconnectedness, the role of ‘moral hazard’, and the responsibilities of governments in handling crises. It will also argue that important mistakes were made in understanding the limitations of inflation targeting in managing economies. Yet – Chapter Five will add – the vulnerability to crisis was not due to what happened inside the financial system alone. Underneath it were global economic events, notably the emergence of a ‘global savings glut’ and the associated credit bubble, partly due to a number of interlinked economic shifts.


pages: 741 words: 179,454

Extreme Money: Masters of the Universe and the Cult of Risk by Satyajit Das

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affirmative action, Albert Einstein, algorithmic trading, Andy Kessler, Asian financial crisis, asset allocation, asset-backed security, bank run, banking crisis, banks create money, Basel III, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, Bonfire of the Vanities, bonus culture, Bretton Woods, BRICs, British Empire, capital asset pricing model, Carmen Reinhart, carried interest, Celtic Tiger, clean water, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, debt deflation, Deng Xiaoping, deskilling, discrete time, diversification, diversified portfolio, Doomsday Clock, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, eurozone crisis, Fall of the Berlin Wall, financial independence, financial innovation, fixed income, full employment, global reserve currency, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, happiness index / gross national happiness, haute cuisine, high net worth, Hyman Minsky, index fund, interest rate swap, invention of the wheel, invisible hand, Isaac Newton, job automation, Johann Wolfgang von Goethe, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, Kevin Kelly, labour market flexibility, laissez-faire capitalism, load shedding, locking in a profit, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, Martin Wolf, merger arbitrage, Mikhail Gorbachev, Milgram experiment, Mont Pelerin Society, moral hazard, mortgage debt, mortgage tax deduction, mutually assured destruction, Naomi Klein, Network effects, new economy, Nick Leeson, Nixon shock, Northern Rock, nuclear winter, oil shock, Own Your Own Home, pets.com, Plutocrats, plutocrats, Ponzi scheme, price anchoring, price stability, profit maximization, quantitative easing, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Ray Kurzweil, regulatory arbitrage, rent control, rent-seeking, reserve currency, Richard Feynman, Richard Feynman, Richard Thaler, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Robert Shiller, Rod Stewart played at Stephen Schwarzman birthday party, rolodex, Ronald Reagan, Ronald Reagan: Tear down this wall, savings glut, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, Slavoj Žižek, South Sea Bubble, special economic zone, statistical model, Stephen Hawking, Steve Jobs, The Chicago School, The Great Moderation, the market place, the medium is the message, The Myth of the Rational Market, The Nature of the Firm, The Predators' Ball, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, trickle-down economics, Turing test, Upton Sinclair, value at risk, Yogi Berra, zero-coupon bond

A tip or gratuity is a noncontractual payment for special service, sometimes related to the relative status of the parties. No doctor or surgeon expects to or receives a tip for doing their job properly. The bonus culture encouraged moral hazard—a focus on narrowly quantifiable outcomes while ignoring wider risks and costs. Elite bankers and traders took risks with other people’s money, aware that if they won the bet they would get a significant share of profits, while suffering no permanent damage if they lost. In a comedy sketch featuring British comedians John Bird and John Fortune, the interviewer asks: “Can we talk about moral hazard?” The banker responds: “About what?” The interviewer reiterates the question: “Moral hazard?” The banker says: “I know what ‘hazard’ means, but what’s the other word?”46 As Adam Smith bemoaned: “All for ourselves, and nothing for anyone else seems, in every age, to have been the vile maxim of the masters of mankind.”47 21.

To reduce risk, banks use a haircut or over collateralization. Banks estimate the worst-case daily change in the value of positions to cover the risk. Event risk, where the value of the position changes a lot quickly, is difficult to measure. Competition reduces the haircuts. LTCM was special, not requiring any haircut. As one observer asked: “Would hedge funds even exist without a fatty dollop of moral hazard somewhere along the great protein chain of lending?”22 At their peak, hedge funds accounted for 30–40 percent of total investment bank earnings. Citadel paid $5.5 billion in trading costs to investment banks,23 the largest portion being interest on borrowings. Citadel’s total and net assets were $166 billion and $13 billion respectively. Trading costs totaled one-third of net assets. Bank dealings with hedge funds frequently entail conflicts of interest.

Rising debt drives up asset prices leading to even more debt that cannot be supported by values or income produced. The system is underpinned by faith in the competence of legislators, regulators and the chattering classes—commentators, gurus and financial journalists. Faux theories, such as Alan Greenspan and Ben Bernanke’s Great Moderation, reassure investors that old problems have been overcome. Moral hazard increases as excessive risk taking and speculation become commonplace. There are increases in beezle42—fraud or embezzlement—as sharp people take advantage of the favorable conditions and abundance of money. As Dr. Pangloss, professor of “metaphysico-theologo-cosmolo-nigology” in Voltaire’s Candide, knew: “All is for the best in the best of all possible worlds.” Bankers were the best of the best.


pages: 701 words: 199,010

The Crisis of Crowding: Quant Copycats, Ugly Models, and the New Crash Normal by Ludwig B. Chincarini

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affirmative action, asset-backed security, automated trading system, bank run, banking crisis, Basel III, Bernie Madoff, Black-Scholes formula, buttonwood tree, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, corporate governance, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, discounted cash flows, diversification, diversified portfolio, family office, financial innovation, financial intermediation, fixed income, Flash crash, full employment, Gini coefficient, high net worth, hindsight bias, housing crisis, implied volatility, income inequality, interest rate derivative, interest rate swap, labour mobility, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low skilled workers, margin call, market design, market fundamentalism, merger arbitrage, Mexican peso crisis / tequila crisis, moral hazard, mortgage debt, Northern Rock, Occupy movement, oil shock, price stability, quantitative easing, quantitative hedge fund, quantitative trading / quantitative finance, Ralph Waldo Emerson, regulatory arbitrage, Renaissance Technologies, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, Sharpe ratio, short selling, sovereign wealth fund, speech recognition, statistical arbitrage, statistical model, systematic trading, The Great Moderation, too big to fail, transaction costs, value at risk, yield curve, zero-coupon bond

Some of the suggestions for reform may lead to a worse situation whereby participants will begin withdrawing early from an institution as they try to get out before the government jumps in and makes mistakes. —Myron Scholes interview, Nobel prizewinner in economics, July 9, 2011 Many people criticized bailouts for creating moral hazard, but it isn’t clear that this was a problem. Many bank equity holders lost almost everything in the bailouts. In all cases, the government bailed out bond holders, who don’t really manage an institution.16 Shareholders and managers run firms. The market needs rules that reduce moral hazard as much as possible before a lender of last resort gets involved. This is no easy task. I presume the Fed understood the importance of the coordination for LTCM in 1998. In 2008, did they really understand that Lehman Brothers wasn’t like an airline?

What if the hedge fund group borrowed heavily using futures contracts and lost more than 10 times its capital? The whole firm might be on the hook. For this reason, separating big banks into smaller pieces by line of business might be a good idea. Individual agents may treat big firms differently. In a deal with a very large firm, a trader might think that the government has issued an implicit rescue guarantee and therefore the situation is less risky. Moral hazard, an economic term used to describe a situation in which a participant insulated from risk behaves differently than a participant fully or partially exposed to risk, enters the equation. Suppose I believe that the government will bail out AIG if it is in trouble. I probably won’t monitor AIG’s risks very carefully. I might even do business with AIG as if it were 100% secure. Knowing this, AIG may take on a lot of risk, because that will not affect its business relationships.

The federal government continually pressured them to support the housing market.21 Supporting housing, after all, was their mission. What’s more, Fannie and Freddie’s managers had a free option. If they continued to bet big on the housing market and kept earning the leveraged spread, profits would be high—and so would individual bonuses. If the housing market collapsed and the GSEs were insolvent, the government would rescue them, just as it had rescued the Farm Credit System in 1987. In economics, this is called the moral hazard problem. No one had a very strong incentive to be vigilant. In fact, the GSEs became slightly more enamored of risk. Between 2004 and 2006, there was a large rise in the subprime mortgage market. Wall Street firms were securitizing these loans, reducing Freddie and Fannie’s share of the total mortgage market between 2003 and 2006 (see Table 10.1). Freddie and Fannie participated in the expanded market.


pages: 375 words: 88,306

The Sharing Economy: The End of Employment and the Rise of Crowd-Based Capitalism by Arun Sundararajan

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3D printing, additive manufacturing, Airbnb, Amazon Mechanical Turk, autonomous vehicles, barriers to entry, bitcoin, blockchain, Burning Man, call centre, collaborative consumption, collaborative economy, collective bargaining, corporate social responsibility, cryptocurrency, David Graeber, distributed ledger, employer provided health coverage, Erik Brynjolfsson, ethereum blockchain, Frank Levy and Richard Murnane: The New Division of Labor, future of work, George Akerlof, gig economy, housing crisis, Howard Rheingold, Internet of things, inventory management, invisible hand, job automation, job-hopping, Kickstarter, knowledge worker, Kula ring, Lyft, megacity, minimum wage unemployment, moral hazard, Network effects, new economy, Oculus Rift, pattern recognition, peer-to-peer lending, profit motive, purchasing power parity, race to the bottom, recommendation engine, regulatory arbitrage, rent control, Richard Florida, ride hailing / ride sharing, Robert Gordon, Ronald Coase, Second Machine Age, self-driving car, sharing economy, Silicon Valley, smart contracts, Snapchat, social software, supply-chain management, TaskRabbit, The Nature of the Firm, total factor productivity, transaction costs, transportation-network company, two-sided market, Uber and Lyft, Uber for X, universal basic income, Zipcar

So even though there may be fewer owners, these owners will be buying more frequently because, in a sense, they are “spending” the capacity of their asset more rapidly. This effect of peer-to-peer rental is exacerbated by what economists call “moral hazard.” While it may be a stereotype, there’s some truth to the fact that renters don’t always care for property as well as its owners do. Think about how you treat a rental car relative to how you treat your own car. You don’t have a long-term commitment. Further, you are acquainted with your own assets whereas renters may not be, which might cause additional wear and tear from unfamiliarity. Thus, despite a variety of technological advances for monitoring and the emergence of sophisticated online reputation systems, moral hazard cannot be fully mitigated. As a consequence, peer-to-peer rental markets will affect the expected lifetime of an asset and increase transaction costs incurred during resale, both from increased usage and potentially less careful use.

Noticing this, the higher quality providers will be reluctant to transact, since they’re not getting a fair price for the higher value they deliver. This lowers the average quality in the market, further lowering the willingness of customers to pay, inducing further unwillingness to transact, and so on, until only the lowest quality providers are left, and the market either unravels, or remains, like Craigslist, on the fringes of the economy. Furthermore, information asymmetry can also lead to “moral hazard”—because parties’ imperfect information limits their ability to contract, one trading partner might display behavior that is less careful (e.g., reckless driving), of lower effort (e.g., lower levels of cleanliness), or somehow riskier than the partner otherwise would have chosen. Prior to the emergence of Internet-enabled marketplaces, the only way to make peer-to-peer economic exchange safe was to embed the exchange into a trusting local community (a village, a family, a suburban neighborhood), or to look to the government or some other third-party certifying body to address these forms of information asymmetry.

See also Car sharing blurring of boundaries and, 141, 142 capital impact of, 115–116 consumer behavior changed by, 110 data science and, 157 driver classification, 183 growth of, 9–11 human connectedness and, 44, 45 impact on traditional taxis, 122–123 LyftLine service, 66 as microentrepreneurship, 125 new social safety net and, 191 platform independence, 194 pricing, supply, and merchandizing, 194, 195 regulatory challenges, 135 social capital and, 62, 64 trust and, 145 MacArthur Foundation, 183 Maghribi traders, 142–144 Malik, Om, 201 Malone, Tom, 69, 72–74 ManagedByQ, 160 Managerial capitalism, 69–70 Mancini, Pia, 23 Mandated transparency, 157 Mantena, Ravi, 57 Manufacturing, additive, 57–58 Markets and hierarchies, 70–72 hybrid, 77–84 peer-to-peer rental market analysis, 125 Martín, Borja, 65 Mashable, 3 Mauss, Marcel, 35 Mazzella, Frédéric, 12–13, 47, 204 McAfee, Andrew, 165–166 McKinsey and Company, 165, 187 Measures of National Well-being, 111 “Medium granularity” goods, 31–32 Meece, Brian, 41 Meeker, Mary, 1 Meetup, 45–46 Mehta, Apoorva, 187 Melding of commerce and community, 13–16 Mendoza, Lenny, 187 Mesh, 28–29, 79–82 Mesh, The (Gansky), 28, 79 Microbusiness, 77, 106–107, 108, 192 Microentrepreneurship, 125 Micro-outsourcing, 77 Microsoft, 54 Miller, Michelle, 161, 187 Minibar, 12 “Mock Trial of the Collaborative Economy, The” (Fillipova), 26 Mohlmann, Mareike, 204 Moore, Gordon, 53 Moore’s law, 53 Mootoosamy, Edwin, 23 Moral hazard, 127–128, 139–140 Mosaic, 59 Mt.Gox, 100–101 Munchery, 12, 45 Murnane, Richard, 165 Murphy, Padden, 136 MySimon, 97 Napster, 58–59, 92, 114–115 NASDAQ, 100 National Association of Realtors, 153 National Domestic Workers Alliance, 192 National Labor Relations Board (NLRB), 179, 183, 184, 186 National League of Cities, 131 Nationwide Mutual Insurance v. Darden, 180–181 NeighborGoods, 15 Nelson, Greg, 187 Netflix, 54 Network effects, local, 117–120 Networks (replacing hierarchies in the sharing economy), 14, 27–29 distributed networks, 32–33 Ng, Andrew, 16 Nguera, Pedro, 44 99 Designs, 197 Nisbet, Robert, 45 North, Douglass C., 131, 144–145, 146 Nosko, Chris, 61 Obama, Barack, 51, 161 Occupy Wall Street, 124 Oei, Shu-Yi, 162–163 Offshoring, 75, 159, 162–164 “Offshoring: The Next Industrial Revolution” (Blinder), 159 OFoto, 28 Okpaku, Joseph, 136 Ola, 3, 6, 116, 121, 203 On-demand platforms/services/workforce, 10–12, 51, 56, 123, 128, 160–162, 164, 168–169, 171, 173–175, 183, 200, 203 OneFineStay, 40, 121.


pages: 137 words: 36,231

Information: A Very Short Introduction by Luciano Floridi

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agricultural Revolution, Albert Einstein, bioinformatics, carbon footprint, Claude Shannon: information theory, conceptual framework, double helix, Douglas Engelbart, George Akerlof, Gordon Gekko, industrial robot, Internet of things, invention of writing, John Nash: game theory, John von Neumann, moral hazard, Nash equilibrium, Norbert Wiener, phenotype, prisoner's dilemma, RAND corporation, RFID, Turing machine

So this is a case of asymmetric information: one player has relevant information that the other player misses. Mark is underinformed, and this can lead to two well-known types of problems: moral hazard and adverse selection. An adverse selection scenario is one in which an absent-minded player like John is more likely to buy an insurance for his car battery because the underinformed player, like Mark, cannot adjust his response to him (e.g. by negotiating a higher premium) due to his lack of information (this is the relevant point here; Mark might also be bound by legal reasons even if he had enough information). A moral hazard scenario is one in which, once John has had the battery of his car insured, he behaves even less carefully, e.g. by leaving the lights on and the iPod re-charging, because Mark, the underinformed player, does not have enough information about his behaviour (or does not have the legal power to use such information; again, the point of interest here is the informational one).


pages: 126 words: 37,081

Men Without Work by Nicholas Eberstadt

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Carmen Reinhart, centre right, deindustrialization, financial innovation, full employment, illegal immigration, John Maynard Keynes: Economic Possibilities for our Grandchildren, Kenneth Rogoff, labor-force participation, low skilled workers, moral hazard, Ronald Reagan, secular stagnation, Simon Kuznets, War on Poverty, women in the workforce, working-age population

If a “work first” principle informed our social welfare policies, we would be emphasizing training and education, job placement, tax credits—performance-conditioned benefits—instead of pensioning men off into permanent retirement in the prime of their lives at taxpayer expense. Twenty years ago—after a national consensus on the moral hazard of publicly subsidizing unwed motherhood finally crystallized—the United States enacted a largely successful “welfare reform” that brought millions of single mothers off welfare and into the workforce.6 It should be possible to form a national consensus to attempt something similar for our millions of idle, un-working, state-supported men of working age. Surely, the moral hazard of providing for them is no lower than providing for jobless single mothers who, unlike most un-working men, were largely busy raising children. Then there is the task of drawing men with a criminal record back into productive work life or introducing them to it for the first time.


pages: 488 words: 144,145

Inflated: How Money and Debt Built the American Dream by R. Christopher Whalen

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Albert Einstein, bank run, banking crisis, Black Swan, Bretton Woods, British Empire, California gold rush, Carmen Reinhart, central bank independence, conceptual framework, corporate governance, cuban missile crisis, currency peg, debt deflation, falling living standards, fiat currency, financial deregulation, financial innovation, financial intermediation, floating exchange rates, Fractional reserve banking, full employment, global reserve currency, housing crisis, interchangeable parts, invention of radio, Kenneth Rogoff, laissez-faire capitalism, liquidity trap, means of production, money: store of value / unit of account / medium of exchange, moral hazard, mutually assured destruction, non-tariff barriers, oil shock, payday loans, Plutocrats, plutocrats, price stability, pushing on a string, quantitative easing, rent-seeking, reserve currency, Ronald Reagan, special drawing rights, The Chicago School, The Great Moderation, too big to fail, trade liberalization, transcontinental railway, Upton Sinclair, women in the workforce

Indeed, the temptation to use a moderate and unexpected inflation tax to wipe out the real value of public debt and avoid the debt deflation of the private sector is powerful, and history may repeat itself—even if the short-term maturity of U.S. liabilities, the risk of a crash of the U.S. dollar and associated runaway rising inflation, and the related risk that the United States’ foreign creditors may pull the plug on the financing of the U.S. deficit may constrain these inflationary biases. Similarly, Chris stresses the role of poor fiscal and monetary policies and botched regulatory policies in triggering recent and not so recent financial crises. But financial crises existed well before there was a central bank causing moral hazard distortions through its lender of last resort role, before misguided regulation and supervision of banks, and well before there was a significant role of federal fiscal policy in the United States. Indeed, my recent book, Crisis Economics: A Crash Course in the Future of Finance (The Penguin Press HC, 2010) shows that financial crises and economic crises driven by irrational exuberance of the financial system and the private sector—unrelated to public policies—existed for centuries before fiscal deviant sovereign and central banks distorted private-sector incentives.

Markets do fail, and they do fail regularly in irrationally exuberant market economies; that is the source of the role of central banks and governments in preventing self-fulfilling and destructive bank runs and collapses of economic activity via Keynesian fiscal stimulus in response to collapse in private demand. The fact that these monetary policies and fiscal policies may eventually become misguided—creating moral hazard and creating large fiscal deficits and debt—does not deny the fact that private market failures—independent of misguided policies—triggered asset and credit bubbles that triggered a public rescue response. Market solutions to market failures don’t work because in periods of panic and irrational depression markets fail given collective action problems in private sector decisions. Still, there is a long-standing debate about whether bubbles and the ensuing crises are due to poor government policies (the traditional conservative and Austrian view) or due to market failure requiring policy reaction (the liberal and Keynesian view).

Paul Volcker has never been a hawk on bank regulation and especially with respect to the largest banks. His concern with the well being of the financial system essentially made the argument for bailing out particular banks. The good of the many, to borrow the old phrase, was more important than market discipline for the one failed institution, even if that meant embracing public subsidies and moral hazard writ large. In a very real sense, Paul Volcker and not Gerry Corrigan was the father of “too big to fail” with respect to the largest U.S. banks. Apart from fighting inflation, Volcker’s legacy to the Fed was to support and enhance the tendency of the central bank to bail out large banks. But the actions of both Volcker and Corrigan were driven by the growing reliance of America on inflation and debt; but they compounded the problem.


pages: 468 words: 145,998

On the Brink: Inside the Race to Stop the Collapse of the Global Financial System by Henry M. Paulson

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asset-backed security, bank run, banking crisis, Bretton Woods, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, Doha Development Round, fear of failure, financial innovation, housing crisis, income inequality, London Interbank Offered Rate, Long Term Capital Management, margin call, moral hazard, Northern Rock, price discovery process, price mechanism, regulatory arbitrage, Ronald Reagan, Saturday Night Live, short selling, sovereign wealth fund, technology bubble, too big to fail, trade liberalization, young professional

In my answers, I attempted to put the crisis in perspective, noting its roots in the housing price collapse and pointing out that a more satisfying solution had been hindered by our archaic financial regulatory structure. “Moral hazard,” I made clear, “is something I don’t take lightly.” But I drew a distinction between our actions in March with Bear Stearns and now with Lehman Brothers. I stressed that unlike with Bear, there had been no buyer for Lehman. For that reason, I said: “I never once considered it appropriate to put taxpayer money on the line in resolving Lehman Brothers.” How could I? There was, in fact, no deal to put money into. In retrospect, I’ve come to see that I ought to have been more careful with my words. Some interpreted them to mean that we were drawing a strict line in the sand about moral hazard, and that we just didn’t care about a Lehman collapse or its consequences. Nothing could have been further from the truth.

Neither of us had heard a word from Jamie, which was good news. I left for the TV studios around 7:30 a.m., making a mental note not to say a word about the negotiations and to stick to my carefully prepared talking points. I taped ABC’s This Week first. The host, George Stephanopoulos, zeroed in on what was on the public’s mind, asking whether we weren’t using taxpayer dollars to bail out Wall Street. “We’re very aware of moral hazard,” I said, adding, “My primary concern is the stability of our financial system.” “Are there other banks in a situation similar to Bear Stearns’s right now?” he wanted to know. “Is this just the beginning?” “Well, our financial institutions, our banks and investment banks, are very strong,” I stressed. “Our markets are resilient, they’re flexible. I’m quite confident we’re going to work our way through this situation.”

I frankly had been disappointed at the negative attitudes of some of the European banks, and I had hoped my counterparts would encourage their banks to be more constructive. I could now see there was no way they would do that. They were understandably shocked by Bear. And of course, the deal was hugely controversial in the U.S. Although plenty of commentators thought it was a brilliant, bold stroke that saved the system, there were just as many who thought it outrageous, a clear case of moral hazard come home to roost. They thought we should have let Bear fail. Among the prominent members of this camp was Senator Richard Shelby, who said the action set a “bad precedent.” To be fair, I could see my critics’ arguments. In principle, I was no more inclined than they were to put taxpayer money at risk to rescue a bank that had gotten itself in a jam. But my market experience had led me to conclude—and rightly so, I continue to believe—that the risks to the system were too great.


pages: 484 words: 136,735

Capitalism 4.0: The Birth of a New Economy in the Aftermath of Crisis by Anatole Kaletsky

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bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Black Swan, bonus culture, Bretton Woods, BRICs, Carmen Reinhart, cognitive dissonance, collapse of Lehman Brothers, Corn Laws, correlation does not imply causation, credit crunch, currency manipulation / currency intervention, David Ricardo: comparative advantage, deglobalization, Deng Xiaoping, Edward Glaeser, Eugene Fama: efficient market hypothesis, eurozone crisis, experimental economics, F. W. de Klerk, failed state, Fall of the Berlin Wall, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, George Akerlof, global rebalancing, Hyman Minsky, income inequality, invisible hand, Isaac Newton, Joseph Schumpeter, Kenneth Rogoff, laissez-faire capitalism, Long Term Capital Management, mandelbrot fractal, market design, market fundamentalism, Martin Wolf, moral hazard, mortgage debt, new economy, Northern Rock, offshore financial centre, oil shock, paradox of thrift, peak oil, pets.com, Ponzi scheme, post-industrial society, price stability, profit maximization, profit motive, quantitative easing, Ralph Waldo Emerson, random walk, rent-seeking, reserve currency, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, sovereign wealth fund, special drawing rights, statistical model, The Chicago School, The Great Moderation, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, too big to fail, Washington Consensus

Many regulators, especially central bankers, still believe that making bank guarantees explicit will create moral hazard. They also claim that governments keep investors on their toes with constructive ambiguity about which bank liabilities might enjoy taxpayer support. These views have been discredited by the financial crisis. When governments left any doubt about which bank liabilities were protected, they usually ended up offering guarantees to all creditors, no matter how junior, in all banks, no matter how small. Constructive ambiguity, far from saving taxpayer money, has turned out to be the greatest source of moral hazard. This experience also refutes suggestions that moral hazard can be overcome by breaking up banks that are too big to fail. Breaking up some banking dinosaurs may well be sensible, for reasons of competition and managerial efficiency.

Every few decades, any capitalist financial system, even a well-regulated and managed one, is likely to suffer a potentially fatal heart attack. To minimize the economic dangers of such emergencies, the government must provide a public safety net for the financial system, just as it provides defibrillators in public places. Caballero points out that the government’s provision of emergency equipment may marginally increase the “moral hazard” of people eating too many hamburgers, but no one would suggest that the right response to heart attacks is simply to blame the victims and let them die. The same reasoning applies to public mechanisms for rescuing banks.41 Henry Paulson’s inability to understand that safeguarding the financial system is a core responsibility of government had deep ideological roots. He could not believe that markets might be fundamentally wrong in guiding the economy or establishing a reasonable price for assets.

Andrews, “Greenspan Concedes Error on Regulation,” New York Times, October 23, 2008. 2 Ayn Rand, “Introducing Objectivism” (August 1962), in The Objectivist Newsletter: 1962-1965, 35. 3 This point is made brilliantly by the British economist, John Kay, in his analysis of the interdependence of economics and politics in all capitalist societies, Culture and Prosperity: The Truth About Markets—Why Some Nations Are Rich but Most Remain Poor. 4 See most recently Angus Maddison’s Growth and Interaction in the World Economy: The Roots of Modernity and Mancur Olson’s Rise and Decline of Nations: Economic Growth, Stagflation, and Social Rigidities. 5 Ricardo Caballero of MIT, in what was probably the most penetrating analysis of the financial crisis by an academic economist, made the specific comparison between credit guarantees and the placement of defibrillators in public places: “The moral hazard perspective is the equivalent of discouraging the placement of defibrillators in public places because of the concern that, upon seeing them, people would have a sudden urge to consume cheeseburgers since they would realize that their chances of surviving a Sudden Cardiac Arrest had risen as a result of the ready access to defibrillators . . . People indeed consume more cheeseburgers than they should, but this is more or less independent of whether defibrillators are visible or not.


pages: 538 words: 121,670

Republic, Lost: How Money Corrupts Congress--And a Plan to Stop It by Lawrence Lessig

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asset-backed security, banking crisis, carried interest, cognitive dissonance, corporate personhood, correlation does not imply causation, crony capitalism, David Brooks, Edward Glaeser, Filter Bubble, financial deregulation, financial innovation, financial intermediation, invisible hand, jimmy wales, Martin Wolf, meta analysis, meta-analysis, Mikhail Gorbachev, moral hazard, place-making, profit maximization, Ralph Nader, regulatory arbitrage, rent-seeking, Ronald Reagan, Silicon Valley, single-payer health, The Wealth of Nations by Adam Smith, too big to fail, upwardly mobile, WikiLeaks, Zipcar

After spending an enormous amount of public funds to save the banks so as to save the financial system, we should at least ensure that we don’t have to save the system again. From this perspective, the fundamental flaw in the system is one that conservatives often harp upon in the context of welfare: the system created a “moral hazard problem.” With welfare, the conservative’s concern is that unemployment payments (intended to cushion the burden of losing a job) may encourage people not to seek a job. With the financial system, the conservative’s concern should be that the promise of a government bailout will encourage the banks to behave more recklessly. Indeed, the evidence of this moral hazard is quite compelling. Banks in the United States have gotten huge in the past ten years. They’ve gotten only bigger after the most recent crisis.36 Before the crisis, each bank could reasonably hope that if it got into trouble, the government would help it.

And we should say, following Zingales, “[I]f you have a sector… where losses are socialized but where gains are privatized, then you destroy the economic and moral supremacy of capitalism.”42 Banks are rational actors. They would not expose our economy to fundamental systemic risk if it didn’t pay—them. And it wouldn’t pay them if they believed that they would go bankrupt when their gambles blew up. So the single most important reform here should have been to end this “moral hazard problem” for banks. And the one simple way to do that would have been to guarantee that banks wouldn’t be bailed out in the future. The reform bill that passed Congress in 2010 tried to make that guarantee. But that guarantee is not worth the PDF it is embedded within. If any of the six largest banks in the United States today faced bankruptcy, the cost that bankruptcy would impose on America would clearly justify the government’s intervening to save it.

But the argument here is about the rationality of this part of our financial policy, however significant this part is. 2. David Moss, “Reversing the Null: Regulation, Deregulation, and the Power of Ideas,” Harvard Business School Working Paper, No. 10-080, Oct. 2010, 3, available at link #75. This graph was derived from Moss’s more extensive original with permission from the author. 3. David Moss, “An Ounce of Prevention: Financial Regulation, Moral Hazard, and the End of ‘Too Big to Fail,’ ” Harvard Magazine (Sept.–Oct. 2009): 25. 4. See Richard A. Posner, The Crisis of Capitalist Democracy (Cambridge, Mass.: Harvard University Press, 2010); and Richard A. Posner, A Failure of Capitalism: The Crisis of ’08 and the Descent into Depression (Cambridge, Mass.: Harvard University Press, 2009). 5. Posner, The Crisis of Capitalist Democracy, 169. 6.


pages: 515 words: 142,354

The Euro: How a Common Currency Threatens the Future of Europe by Joseph E. Stiglitz, Alex Hyde-White

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bank run, banking crisis, barriers to entry, battle of ideas, Berlin Wall, Bretton Woods, capital controls, Carmen Reinhart, cashless society, central bank independence, centre right, cognitive dissonance, collapse of Lehman Brothers, collective bargaining, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, currency peg, dark matter, David Ricardo: comparative advantage, disintermediation, diversified portfolio, eurozone crisis, Fall of the Berlin Wall, fiat currency, financial innovation, full employment, George Akerlof, Gini coefficient, global supply chain, Growth in a Time of Debt, housing crisis, income inequality, incomplete markets, inflation targeting, investor state dispute settlement, invisible hand, Kenneth Rogoff, knowledge economy, labour market flexibility, labour mobility, manufacturing employment, market bubble, market friction, market fundamentalism, Martin Wolf, Mexican peso crisis / tequila crisis, moral hazard, mortgage debt, neoliberal agenda, new economy, open economy, paradox of thrift, pension reform, pensions crisis, price stability, profit maximization, purchasing power parity, quantitative easing, race to the bottom, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, secular stagnation, Silicon Valley, sovereign wealth fund, the payments system, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, transfer pricing, trickle-down economics, Washington Consensus, working-age population

At the time the crisis broke out, Greek debt was around 109 percent of GDP—lower than US debt at the end of World War II (118 percent), much lower than Japan’s debt now (246 percent) and the UK’s debt at the end of World War II (which reached some 250 percent).43 If one manages to “grow” the economy, increase GDP, and keep interest rates low, this debt-to-GDP ratio can be brought down, and dramatically so, as both the history of the United States and the UK demonstrated. But if one imposes stifling conditions and charges high interest rates, then the economy will stagnate, and the debt-to-GDP ratio will increase. Some in Germany (and elsewhere) claim high interest rates were necessary to discourage moral hazard, the risk that governments would spend recklessly and then turn to Europe for assistance. But no government would willingly put itself through the torture that Greece has endured. Moreover, whatever mistakes in lending occurred earlier—punishing Greece today doesn’t rectify yesterday’s mistakes. The real moral hazard problem arises for banks, who have an incentive to induce countries to borrow excessively, knowing that current politicians benefit from the increased spending and future politicians pay the price. Repeated bank bailouts encourage this kind of behavior: the Mexican, Latin American, and East Asian bailouts, each of which bears the name of a country, are really bailouts of the European and American banks that lent recklessly.

They are, in fact, just one of the many forms of subsidy to the financial sector, especially the big banks,44 sometimes hidden in the lower interest rate they pay to those who provide them funds because of anticipation of the bailouts. If instead of just bailing out failing banks, the governments took shares in those banks, then the country’s fiscal position would be that much stronger when the banks rebounded, and perhaps the banks would be more prudent in their lending.45 True to history, Germany and the Troika did little to address the banks’ moral hazard in the case of Greece and some of the other European bailouts. Indeed, as we saw in the case of Ireland, the ECB demanded (secretly) that Ireland bail out its banks. Whatever the reason, Germany’s demand for high interest rates was well in excess of those at which Germany could borrow. This dealt a blow to any notion of European solidarity: What does solidarity mean if one country is able and willing to make a profit off its neighbor in its time of need?

Glenn Hubbard (Chicago: University of Chicago Press, 1991), pp. 33–68; Peter Temin, Lessons from the Great Depression (Cambridge, MA: MIT Press, 1989); Barry Eichengreen and Jeffrey Sachs, “Exchange Rates and Economic Recovery in the 1930s,” Journal of Economic History 45, no. 4 (1985): 925–46. 19 Even from a social point of view, some government restrictions on firing (requiring severance pay) may be desirable. See Carl Shapiro and Joseph E. Stiglitz, “Equilibrium Unemployment as a Worker Discipline Device,” American Economic Review 74, no. 3 (1984): 433–44; and Patrick Rey and Joseph E. Stiglitz, “Moral Hazard and Unemployment in Competitive Equilibrium,” 1993 working paper. 20 These theories arguing that lowering wages lowers workers’ productivity were first developed in the context of developing countries, where it was observed that low nutrition resulting from low wages hurt productivity. See Harvey Leibenstein, Economic Backwardness and Economic Growth (New York: Wiley, 1957). In a series of papers, I then extended the idea to advanced countries, focusing on the fact that lower wages lead to more labor turnover, and that increases training costs, beginning with Joseph E.


pages: 264 words: 74,313

Wars, Guns, and Votes: Democracy in Dangerous Places by Paul Collier

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dark matter, deskilling, failed state, moral hazard, out of africa, price stability, structural adjustment programs

In the absence of states, ethnicity was the obvious basis for collective action, and in a rural society bumping along at a subsistence level of income, one form of collective action was supremely important: insurance. Life at subsistence is risky: if you fall sick when you should be plowing, planting, or harvesting, your income will collapse. If vermin eat your food stores, you face starvation. You need catastrophe insurance. The problem with insurance is what economists coyly term moral hazard: if I’m insured, what the heck! If you could insure yourself against a decline in income, why get up in the morning? And so such insurance does not exist unless the moral hazard problem can be solved. The solution to moral hazard is not indignantly to protest that the insurer should not doubt your good faith, it is to make your behavior observable. Only if the insurer can see that you are trying your best does the insurance become feasible. For a private insurance company such observation would be prohibitively expensive, but for a community it is feasible.


pages: 304 words: 80,965

What They Do With Your Money: How the Financial System Fails Us, and How to Fix It by Stephen Davis, Jon Lukomnik, David Pitt-Watson

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Admiral Zheng, banking crisis, Basel III, Bernie Madoff, Black Swan, centralized clearinghouse, clean water, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, crowdsourcing, David Brooks, Dissolution of the Soviet Union, diversification, diversified portfolio, en.wikipedia.org, financial innovation, financial intermediation, Flash crash, income inequality, index fund, invisible hand, London Whale, Long Term Capital Management, moral hazard, Northern Rock, passive investing, performance metric, Ponzi scheme, principal–agent problem, rent-seeking, Ronald Coase, shareholder value, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, Steve Jobs, the market place, The Wealth of Nations by Adam Smith, transaction costs, Upton Sinclair, value at risk, WikiLeaks

But in banking, most of the finance is provided by depositors and lenders, often with explicit or implicit guarantees from the government. This creates a danger that prudent profit-seeking can morph into imprudent risk-taking. If every thing goes well, the executives reap the rewards, but if it doesn’t, the troubles are laid at the feet of the public taxpayers. Academics and bank regulators call this situation “moral hazard,” but at its heart, it is the same “Heads we win, tails you lose” philosophy that we all recognize as grossly unfair. The inherent nature of banks makes moral hazard more than an academic concern. The International Finance Corporation (IFC, the private sector arm of the World Bank) explains in its training guide for bank directors that the very business model of banks makes them inherently fragile.32 Growth, for banks, is a tricky proposition. The IFC compares the situation in which banks find themselves to the Greek myth of Icarus, who dons wings made from feathers and wax.

See also Economic modeling Max Planck Institute for Research on Collective Goods, 215 McRitchie, James, 116–17 Mercer, 122 Merrill Lynch, 44 Merton, Robert, 260n20 MFS Technologies, 82 Microeconomics, 179, 181–82 Millstein Center for Corporate Governance and Performance, 265n13 Millstein, Ira, 8 Minow, Nell, 207 Mirvis, Theodore, 8 Misalignment indicators, 104 Molinari, Claire, 112 Money managers, using collective action to allow focus on benefits for all, 89–90 “The Monkey Business Illusion” (video), 174 Monks, Bob, 62 Moral hazard, 73 Morality: economics and, 158 trade, 177 Morningstar, 34, 35, 36–37, 101, 122, 208, 225 Mortgages: chain of agents involved in, 31–32 subprime, 38, 40, 47 Murninghan, Marcy, 122 Mutual funds: agency capitalism and, 77–78 boards of, 205–6, 265n14 chain of agents in, 31 disclosure rules, 97 duration of holdings, 243n4, 258n41 failure to protect investors’ interests, 6–7 governance and performance of, 101–4, 224–25 grassroots campaigns influencing, 117 self-evaluation of, 110 votes on shareholder resolutions, 102 Mylan Laboratories, 81 Myopia, 66, 68 National Employment Savings Trust (NEST), 111, 206, 208 National governance code, 205, 265n13 Navalny, Alexei, 115–16 NEST.


pages: 305 words: 69,216

A Failure of Capitalism: The Crisis of '08 and the Descent Into Depression by Richard A. Posner

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Andrei Shleifer, banking crisis, Bernie Madoff, collateralized debt obligation, collective bargaining, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, diversified portfolio, equity premium, financial deregulation, financial intermediation, Home mortgage interest deduction, illegal immigration, laissez-faire capitalism, Long Term Capital Management, market bubble, moral hazard, mortgage debt, oil shock, Ponzi scheme, price stability, profit maximization, race to the bottom, reserve currency, risk tolerance, risk/return, Robert Shiller, Robert Shiller, savings glut, shareholder value, short selling, statistical model, too big to fail, transaction costs, very high income

But the mistakes were systemic —the product of the nature of the banking business in an environment shaped by low interest rates and deregulation rather than the antics of crooks and fools. Laissez-faire capitalism failed us, but government allowed the preconditions of depression to develop and wreak havoc with the economy. And its responses to the crisis were late, slow, indecisive, and poorly articulated. The responses also created "moral hazard" (the tendency to engage in risky behavior if one is insured against the consequences of the risks' materializing). They did this by eliminating the limits on federal deposit insurance of bank deposits and by extending that insurance to checkable accounts in money market funds, but more important by bailing out failing firms deemed "too big to fail"—an incentive for corporate giantism and financial irresponsibility (which go hand in hand because the difficulty of controlling subordinates grows with the size of an organization).

The government gratuitously disrupted the operations of hedge funds by limiting short selling—at the height of the banking crisis the Securities and Exchange Commission forbade short selling of financial stocks. And by substantially increasing the federal deficit, the government's responses to the crisis are sowing the seeds of a future inflation. But of these criticisms, the main ones — the creation of moral hazard and the planting of the seeds of a future inflation—concern the unavoidable side effects of any effective measures to limit a depression. To blame the government for the depression is questionable in two respects. First, were there no government regulation of the economy, there probably would still have been a depression, because even without the Federal Reserve's loose monetary policy in the early 2000s there would have been enough capital from abroad to keep interest rates low unless the Fed had been more alert than it was to the risk of depression that low interest rates create.

Although bailouts do not save all firms, all careers, or all shareholder values, firms that are saved by a bailout retain employees who would have lost their jobs had the firm not been saved, and equity values are preserved that would disappear in bankruptcy. Still, a bailout is a traumatic experience. Even holders of secure debt are often badly hurt, because the value of their collateral falls. But overriding moral-hazard concerns is the fact that depressions would be significantly deeper and last significantly longer were government unwilling to take aggressive steps to counter them with monetary and fiscal measures. Second, in financial regulation the line between government and the private sector is blurred. This was especially true in the Bush Administration. Bernanke and Paulson are neither politicians nor career civil servants, though Bernanke has spent the last six years in government, Paulson only the last two (and he's gone now), after a career as an investment banker.


pages: 268 words: 74,724

Who Needs the Fed?: What Taylor Swift, Uber, and Robots Tell Us About Money, Credit, and Why We Should Abolish America's Central Bank by John Tamny

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Airbnb, bank run, banks create money, Bernie Madoff, bitcoin, Bretton Woods, Carmen Reinhart, correlation does not imply causation, Credit Default Swap, crony capitalism, crowdsourcing, Donald Trump, Downton Abbey, fiat currency, financial innovation, Fractional reserve banking, full employment, George Gilder, Home mortgage interest deduction, Jeff Bezos, job automation, Joseph Schumpeter, Kenneth Rogoff, Kickstarter, liquidity trap, Mark Zuckerberg, market bubble, moral hazard, mortgage tax deduction, NetJets, offshore financial centre, oil shock, peak oil, Peter Thiel, price stability, profit motive, quantitative easing, race to the bottom, Ronald Reagan, self-driving car, sharing economy, Silicon Valley, Silicon Valley startup, Steve Jobs, The Wealth of Nations by Adam Smith, too big to fail, Uber for X, War on Poverty, yield curve

Ludwig von Mises, The Theory of Money and Credit (Indianapolis, Ind.: Liberty Fund, 1912), 341. 2. Rothbard quoted in Ron Paul, “Fractional Reserve Banking, Government, and Moral Hazard,” Financial Sense, July 9, 2012. 3. von Mises, Theory of Money and Credit, 341. 4. Adam Fergusson, When Money Dies: The Nightmare of Deficit Spending, Devaluation, and Hyperinflation in Weimar Germany (New York: Public Affairs, 2010), 113. My emphasis. 5. Ibid., 87. 6. Ibid., 140. My emphasis. 7. von Mises, Theory of Money and Credit, 379. 8. Lawrence W. Reed, Excuse Me, Professor: Challenging the Myths of Progressivism (Washington, D.C.: Regnery, 2015), 154. 9. Ron Paul, “Fractional Reserve Banking, Government, and Moral Hazard,” Financial Sense, July 9, 2012. 10. Eric Margolis, “The Terror of Chinese Paper,” LewRockwell.com, August 29, 2015. 11. Benn Steil, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order (Princeton, N.J.: Princeton University Press, 2013), 139. 12.

To see why, readers need only ask themselves how much due diligence they conduct on banks before depositing with them. Odds are very little. Why bother? The deposit is insured. Citibank is regularly in trouble; a former Fed official told this writer that it’s been bailed out five times in the last twenty-five years. But have its depositors ever suffered the bank’s incompetence? Obviously not. The “moral hazard” is we! In that case, an ideal world would have neither government-dictated reserve requirements nor the FDIC. Just as insurance companies insure against all manner of other calamities, so will they insure bank deposits. For banks with a reputation for sound lending practices, the cost of insuring one’s account would be rather small. It would reflect the insurer’s confidence in the bank. For newer banks with less of a lending history, the cost of private deposit insurance would be greater, but the interest paid to the depositor would be more; the latter a reflection of the bank’s lack of a track record.


pages: 840 words: 202,245

Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present by Jeff Madrick

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accounting loophole / creative accounting, Asian financial crisis, bank run, Bretton Woods, capital controls, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, desegregation, disintermediation, diversified portfolio, Donald Trump, financial deregulation, fixed income, floating exchange rates, Frederick Winslow Taylor, full employment, George Akerlof, Hyman Minsky, income inequality, index fund, inflation targeting, inventory management, invisible hand, laissez-faire capitalism, locking in a profit, Long Term Capital Management, market bubble, minimum wage unemployment, Mont Pelerin Society, moral hazard, mortgage debt, new economy, North Sea oil, Northern Rock, oil shock, price stability, quantitative easing, Ralph Nader, rent control, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, Ronald Reagan: Tear down this wall, shareholder value, short selling, Silicon Valley, Simon Kuznets, technology bubble, Telecommunications Act of 1996, The Chicago School, The Great Moderation, too big to fail, union organizing, V2 rocket, value at risk, Vanguard fund, War on Poverty, Washington Consensus, Y2K, Yom Kippur War

Only Britain’s Barclays Bank came forward, but the British financial regulator refused to approve the purchase. Few accepted the claim that Washington could not have taken over the firm if it had wanted to. Bernanke, Geithner, and Paulson were becoming confident in August that the markets might be able to withstand a Lehman bankruptcy, and Paulson particularly feared creating moral hazard—overconfidence that the government would always bail out firms in trouble, thereby encouraging them to take risks. There was rising public anger about bailouts and conservative anger about the creation of moral hazard. In letting Lehman fail, however, the Fed and Treasury were largely flying blind. They presumed that the securitized mortgage products had been distributed among investors around the world—and therefore losses would be dispersed and readily manageable. In fact, much of the risk had been taken on by Joe Cassano at AIG, even though that had stopped by late 2005.

The unemployment rate would have reached 16.5 percent. It would have been a full-fledged depression. One in four Americans looking for a full-time job would not have been able to find one. Average wages may have fallen sharply for those with a job. Some economists argued that because bankers knew the federal government would bail them out, they took undue risks that led to speculative excess—such moral hazard, these economists argue, meant that the crisis was government’s fault. But this argument is exaggerated, implying that speculative bubbles are more rational than they are. Damaging financial crises occurred throughout nineteenth-century and early-twentieth-century America when no government entity could genuinely be counted on to bail out big lenders. To take a contemporary example, when Mexico was bailed out in 1994 with a $40 billion rescue package of loans and guarantees from the U.S.

Treasury, many economists argued that this only made future crises inevitable because outside investors would invest recklessly in such countries again, knowing they would be bailed out if necessary. In fact, investment in Mexico not only failed to revive, but fell and stayed low in Mexico and other developing countries at the time. There are many other examples of nations that got government bailouts without a revival in investment. The nature of herd behavior is to cast common sense aside, whether a lender of last resort exists or not. Moral hazard is among the causes of overspeculation but not likely the determining part. Herd behavior is hardly rational. And the extent of federal activity in 2008 and 2009 was far greater than ever before. No one on Wall Street could have anticipated such aggressive responses. The larger concern by far is what would have happened had government not taken the actions it did. Blinder and Zandi may well have understated the consequences.


pages: 349 words: 134,041

Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives by Satyajit Das

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accounting loophole / creative accounting, Albert Einstein, Asian financial crisis, asset-backed security, Black Swan, Black-Scholes formula, Bretton Woods, BRICs, Brownian motion, business process, buy low sell high, call centre, capital asset pricing model, collateralized debt obligation, complexity theory, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, currency peg, disintermediation, diversification, diversified portfolio, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, Haight Ashbury, high net worth, implied volatility, index arbitrage, index card, index fund, interest rate derivative, interest rate swap, Isaac Newton, job satisfaction, locking in a profit, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, Marshall McLuhan, mass affluent, merger arbitrage, Mexican peso crisis / tequila crisis, moral hazard, mutually assured destruction, new economy, New Journalism, Nick Leeson, offshore financial centre, oil shock, Parkinson's law, placebo effect, Ponzi scheme, purchasing power parity, quantitative trading / quantitative finance, random walk, regulatory arbitrage, risk-adjusted returns, risk/return, shareholder value, short selling, South Sea Bubble, statistical model, technology bubble, the medium is the message, time value of money, too big to fail, transaction costs, value at risk, Vanguard fund, volatility smile, yield curve, Yogi Berra, zero-coupon bond

Traders are given every incentive to take risk and generate short-term profits. Finely calibrated bonus schemes encourage the ‘upfronting’ and overstatement of earnings. The absurdities of the compensation scheme lie at the heart of this perverse system. When things go wrong, there is always the ‘rogue’ trader. The implication is that nothing could have been done. It exonerates the management from any malfeasance. Barings provides an insight into this world of ‘moral hazard’ and ‘adverse incentives’. In the year Leeson’s trading losses destroyed the bank, its total profits were about £37 million. Of this amount, Leeson’s ‘profits’ were £41 million. Peter Baring, chairman, observed that it ‘was not all that terribly difficult to make money in the securities business’. Baring had a system where 50% of net profits were paid into a bonus pool, with the typical director’s compensation a 75% bonus and 25% salary ratio.

In 2000, it entered into discussions with two major bankers resulting in a significant ‘restructuring’ of some bank loans. The changes included longer maturity, increased interest rates and new conditions, improving the position of the lender. The maturity extension was a restructuring credit event under a CDS on Conseco. The lenders to Conseco involved in restructuring loans had also bought protection in the CDS market. This created a ‘moral hazard’. The lenders would benefit from a restructuring as it would be a credit event under their CDS. The lenders took refuge behind Chinese walls. Conseco had a lot of outstanding debt. After the restructuring, the short-term bonds traded at around 90% of face value. Conseco’s longerdated bonds traded at prices around 60–70% of face value. Remember, buyers of protection have the ability to deliver any bond or loan that is within the specified basket.

The concept of average credit losses proved average – it seemed the worst case was much worse. If the average was made of one year of very large losses and several years of no losses, then that didn’t work well either. Some CDOs were actively managed. Managers had been appointed to trade the portfolios, the idea being that they would minimize losses by selling deteriorating credits. They usually compounded losses by making wrong trading decisions. There were ‘moral hazards’. Managers had to invest equity in the CDO they managed which was designed to ‘align interests’ and ‘overcome agency conflicts’. It was a noble idea – when credit losses wiped out equity, the managers lost money. It was their personal wealth, which didn’t worry anybody, but the incentives shifted worryingly. The managers now ramped up the risk; they bought a lot of lottery tickets; dodgy companies whose bonds were trading at 35% of face value suddenly represented compelling investments.


pages: 358 words: 106,729

Fault Lines: How Hidden Fractures Still Threaten the World Economy by Raghuram Rajan

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accounting loophole / creative accounting, Andrei Shleifer, Asian financial crisis, asset-backed security, bank run, barriers to entry, Bernie Madoff, Bretton Woods, business climate, Clayton Christensen, clean water, collapse of Lehman Brothers, collateralized debt obligation, colonial rule, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, diversification, Edward Glaeser, financial innovation, floating exchange rates, full employment, global supply chain, Goldman Sachs: Vampire Squid, illegal immigration, implied volatility, income inequality, index fund, interest rate swap, Joseph Schumpeter, Kenneth Rogoff, knowledge worker, labor-force participation, Long Term Capital Management, market bubble, Martin Wolf, medical malpractice, microcredit, moral hazard, new economy, Northern Rock, offshore financial centre, open economy, price stability, profit motive, Real Time Gross Settlement, Richard Florida, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, school vouchers, short selling, sovereign wealth fund, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, upwardly mobile, Vanguard fund, women in the workforce, World Values Survey

Among its failings in the recent crisis include distorted incentives, hubris, envy, misplaced faith, and herd behavior. But the government helped make those risks look more attractive than they should have been and kept the market from exercising discipline, perhaps even making it applaud such behavior. Government interventions in the aftermath of the crisis have, unfortunately, fulfilled the beliefs of the financial sector. Political moral hazard came together with financial-sector moral hazard in this crisis. The worrisome reality is that it could all happen again. Put differently, the central problem of free-enterprise capitalism in a modern democracy has always been how to balance the role of the government and that of the market. While much intellectual energy has been focused on defining the appropriate activities of each, it is the interaction between the two that is a central source of fragility.

See health care; physicians medical malpractice Medicare Merrill Lynch Mexico: conditional cash transfers financial crisis of Mian, Atif microcredit middle class migration mobility: economic factors restricting of workers models, economic Mohamad, Mahathir monetary policy: credit expansion and financial stability and housing market and improvements in Japanese Keynesian lags in political influences on reforms of of United States, See also central banks; interest rates money-market funds moral hazard Morgan, J. P., See also JP Morgan Morrice, Brad mortgage-backed securities: credit risk of Fannie Mae and Freddie Mac issues federal purchases of held by banks investors in ratings of risks of, subprime mortgages in tail risks of tranches of mortgage brokers mortgage insurance mortgages: defaults on deregulation of thrift industry FHA foreclosures of historical evolution of interest rates on predatory lending traditional lending process for, See also subprime mortgage market motivations multilateral financial institutions: influence of lending by reforms of See also International Monetary Fund; World Bank mutual fund management companies national home ownership strategy, See also home ownership nationalism Nehru, Jawaharlal New Century Financial New Deal New York City No Child Left Behind Act of noncognitive skills Northern Rock Obama, Barack Obama administration Office of Thrift Supervision O’Neal, Stanley opportunities organizational capital ownership society, See also home ownership Park Chung Hee Paulson, Henry J.


pages: 261 words: 103,244

Economists and the Powerful by Norbert Haring, Norbert H. Ring, Niall Douglas

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accounting loophole / creative accounting, Affordable Care Act / Obamacare, Albert Einstein, asset allocation, bank run, barriers to entry, Basel III, Bernie Madoff, British Empire, central bank independence, collective bargaining, commodity trading advisor, corporate governance, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, diversified portfolio, financial deregulation, George Akerlof, illegal immigration, income inequality, inflation targeting, Jean Tirole, job satisfaction, Joseph Schumpeter, knowledge worker, labour market flexibility, law of one price, Long Term Capital Management, low skilled workers, market bubble, market clearing, market fundamentalism, means of production, minimum wage unemployment, moral hazard, new economy, obamacare, open economy, pension reform, Ponzi scheme, price stability, principal–agent problem, profit maximization, purchasing power parity, Renaissance Technologies, rolodex, Sergey Aleynikov, shareholder value, short selling, Steve Jobs, The Chicago School, the payments system, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, ultimatum game, union organizing, working-age population, World Values Survey

This is a time when it is convenient or even required for many CEOs to sell their stock options. It turned out that if CEOs had large amounts of options, the stock price of the company tended to be unusually high in the months around the retirement, only to fall back to normal soon afterwards. In the group of companies whose CEOs had low option holdings, this was not the case. It would not be hard to devise rules that would take the timing decision and thus the moral hazard away from managers. Law and finance scholar Jesse Fried suggested in 1998 that executives be required to announce their insider trades in advance or that firms require that sales be carried out gradually over a specified period of time. However, it is rare that such effective measures are taken (Fried 1998). At most companies have introduced trading windows or blackout periods, which limit executives to unloading their shares at certain times of the year.

Cambridge, MA: Harvard University Press. 228 ECONOMISTS AND THE POWERFUL Chan, Swell. 2010. “Fifteen Economists Issue Crisis-Prevention Manual.” New York Times, June 15. Chau, Nancy. 2009. “Sweatshop Equilibrium.” IZA Discussion Paper 4363. Chen, Joseph, Samuel Hanson, Harrison Hong and Jeremy C. Stein. 2008. “Do Hedge Funds Profit from Mutual-Fund Distress?” NBER Working Paper 13786. Chetty, Ray. 2008. “Moral Hazard vs. Liquidity and Optimal Unemployment Insurance.” Journal of Political Economy 116: 173–234. Citizens for Tax Justice. 2011. “Report: 280 Most Profitable U.S. Corporations Shelter Half Their Profits from Taxes; Thirty Companies Paid Less Than Zero in Taxes in the Last Three Years,” November 3. http://www.ctj.org/corporatetaxdodgers/ CorporateTaxDodgersPR.pdf (accessed March 28, 2012). Clark, John Bates. 1899/2001.

American Economic Review 96: 369–86. Faccio, Mara, Ronald W. Masulis and John J. McConnell. 2006. “Political Connections and Corporate Bailouts.” Journal of Finance 61: 2597–2635. Farber, Henry S. 2005. “What Do We Know About Job Loss in the United States: Evidence from the Displaced Workers Survey, 1984–2004.” Federal Reserve Bank of Chicago Regional Review: 13–28. Farhi, Emmanuel and Jean Tirole. 2009. “Collective Moral Hazard, Maturity Mismatch and Systemic Bailouts.” NBER Working Paper 15138. Farhi, Emmanuel and Iván Werning. 2008. “The Political Economy of Nonlinear Capital Taxation.” Working paper. Feenstra, Robert, Benjamin Mandel, Marshall B. Reisdorf and Matthew J. Slaughter. 2009. “Effects of Terms of Trade and Tariff Changes on the Measurement of U.S. Productivity Growth.” NBER Working Paper 1592. Fehr, Ernst, Lorenz Goette and Christian Zehnder. 2009.


pages: 356 words: 103,944

The Globalization Paradox: Democracy and the Future of the World Economy by Dani Rodrik

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affirmative action, Asian financial crisis, bank run, banking crisis, bilateral investment treaty, borderless world, Bretton Woods, British Empire, capital controls, Carmen Reinhart, central bank independence, collective bargaining, colonial rule, Corn Laws, corporate governance, corporate social responsibility, credit crunch, Credit Default Swap, currency manipulation / currency intervention, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, Doha Development Round, en.wikipedia.org, eurozone crisis, financial deregulation, financial innovation, floating exchange rates, frictionless, frictionless market, full employment, George Akerlof, guest worker program, Hernando de Soto, immigration reform, income inequality, income per capita, joint-stock company, Kenneth Rogoff, labour market flexibility, labour mobility, land reform, Long Term Capital Management, low skilled workers, margin call, market bubble, market fundamentalism, Martin Wolf, Mexican peso crisis / tequila crisis, microcredit, Monroe Doctrine, moral hazard, night-watchman state, non-tariff barriers, offshore financial centre, oil shock, open borders, open economy, price stability, profit maximization, race to the bottom, regulatory arbitrage, savings glut, Silicon Valley, special drawing rights, special economic zone, The Wealth of Nations by Adam Smith, Thomas L Friedman, Tobin tax, too big to fail, trade liberalization, trade route, transaction costs, tulip mania, Washington Consensus, World Values Survey

Did the problem lie with unscrupulous mortgage lenders? Spendthrift borrowers? Faulty practices by credit rating agencies? Too much leverage on the part of financial institutions? The global savings glut? Too loose monetary policy by the Federal Reserve? Government guarantees for Fannie Mae and Freddie Mac? The U.S. Treasury’s rescue of Bear Stearns and AIG? The U.S. Treasury’s refusal to bail out Lehman Brothers? Greed? Moral hazard? Too little regulation? Too much regulation? The debate on these questions remains fierce and will no doubt continue for a long time. In the bigger scheme of things, these questions interrogate mere details. More fundamentally, our basic narrative has lost its credibility and appeal. It will be quite some time before any policy maker can be persuaded that financial innovation is an overwhelming force for good, that financial markets are best policed through self-regulation, or that governments can expect to let large financial institutions pay for their own mistakes.

If the answer is not an unqualified yes to these and a multitude of other similar questions, financial markets will fail. Unfortunately, such failings are legion, which is why we have become so accustomed to the financial market pathologies they produce. Economists are not unaware of these problems. The economics literature is chockful of analyses of these failings, which go by names such as asymmetric information, limited liability, moral hazard, agency costs, multiple equilibria, systemic risk, implicit guarantees, information cascades, and so on. Each one of these phenomena has been studied to death with intricate mathematical reasoning and empirical illustrations. By now most economists also understand that these problems have not been adequately addressed in the global economy. Domestic finance is underpinned by common standards, deposit insurance, bankruptcy rules, court-enforced contracts, a lender-of-last-resort, a fiscal backstop, and an alphabet soup of regulatory and supervisory agencies.

Terrones, “Growth and Volatility in an Era of Globalization,” IMF Staff Papers, vol. 52, Special Issue (September 2005). 19 “Crisis may be worse than Depression, Volcker says,” Reuters, February 20, 2009 (http://uk.reuters.com/article/ idUKN2029103720090220). 20 Craig Torres, “Bernanke Says Crisis Damage Likely to Be Long-Lasting,” Bloomberg News Service, April 17, 2009. 21 David A. Moss, “An Ounce of Prevention: Financial regulation, moral hazard, and the end of ‘too big to fail,’” Harvard Magazine (September–October 2009) (http://harvardmagazine.com/2009/09/ financial-risk-management-plan?page=0,1). 22 Enrque G. Mendoza and Vincenzo Quadrini, “Did Financial Globalisation Make the US Crisis Worse?” VoxEU.org, November 14, 2009 (http://voxeu.org/index.php?q=node/4206). 23 And not just financial havens. The reason that AIG’s credit-default swap operations were based in London is that this was a much less heavily regulated environment than New York. 24 Simon Johnson, “The Quiet Coup,” The Atlantic (May 2008) (http://www.theatlantic.com/doc/ 200905/imf-advice). 25 Johnson and I had often taken stands on the opposite sides of the argument, while remaining friends and respectful of each other’s views.


pages: 227 words: 62,177

Numbers Rule Your World: The Hidden Influence of Probability and Statistics on Everything You Do by Kaiser Fung

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American Society of Civil Engineers: Report Card, Andrew Wiles, Bernie Madoff, Black Swan, call centre, correlation does not imply causation, cross-subsidies, Daniel Kahneman / Amos Tversky, edge city, Emanuel Derman, facts on the ground, Gary Taubes, John Snow's cholera map, moral hazard, p-value, pattern recognition, profit motive, Report Card for America’s Infrastructure, statistical model, the scientific method, traveling salesman

The state regulator took a farcical position: “Could there be another monster like Katrina or worse? God forbid if there were. All bets would be off at that point.” We’ve seen this script before, and it did not have a happy ending. And the troubles do not end there. One might expect the devastation wrought by Hurricane Wilma to have deterred Floridians from moving to the coast, but the trend has showed no sign of easing. Economists blame “moral hazard”: coastal dwellers are less worried about hurricanes because they expect the state to continue the unending bailouts and offer an implicit backstop. New residents believe that if their homes should fall, someone else will pay for the reconstruction, so why not enjoy living along the coast? This alarming trend further aggravates the economics of hurricane insurance. The already heavy concentration of simultaneous risks has gained even more heft.

Queue”), 20, 23 Lau, Rich, 21 Laval, Bruce, 17 Lee, Wen Ho, 128 Lewis, Carl, 112 Lewis, Michael, 9, 87 Lotteries, 137–38, 181 insider wins, 143–46, 151–53, 177–78, 179 odds of winning, 137, 143 percentage of Americans playing, 138 Lowell, Mike, 96, 98, 100, 102, 107, 112, 124 Lund, Zach, 112 Madoff, Bernie, 156 Major League Baseball, 9, 98–100, 106–7, 112, 114–16 Manhattan Project, 9 Margin of error, 174 Marston, William, 113, 117 Martinez, David, 112 McGuinty, Dalton, 145 McGwire, Mark, 95, 98–99, 107, 114 Measuring Up (Koretz), 73 Minnesota Department of Transportation, 15, 21, 158 “Minnesota Merge,” 14–15 Mitchell, George, 100, 116 Moneyball (Lewis), 9 Moral hazard, 93 Munich Re, 87 Muris, Tim, 29, 46 Nightingale, Florence, 3 Norris, Craig, 95, 132, 133 Obama, Barack, 2, 116 Odds, improbable, 137–54, 178–81. See also Airplane crashes; Lotteries O’Malley, T. V., 118 OutbreakNet, 41 Palmeiro, Rafael, 99, 112, 114 Pawlenty, Tim, 22 Performance-enhancing drugs, 95–96, 98–116, 130–31, 160–63, 175–76 Plantenga, Melissa, 33, 41, 42, 173 Poe Financial Group (Bill Poe), 82–86, 89, 91–92, 159, 171 Polygraph tests, 113–33, 167, 181.


pages: 165 words: 45,129

The Economics of Inequality by Thomas Piketty, Arthur Goldhammer

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affirmative action, Capital in the Twenty-First Century by Thomas Piketty, collective bargaining, conceptual framework, deindustrialization, Gini coefficient, income inequality, low skilled workers, means of production, moral hazard, purchasing power parity, Simon Kuznets, The Bell Curve by Richard Herrnstein and Charles Murray, very high income, working-age population

The lender will also want to make sure that the borrower has sufficient incentives to do what needs to be done over a long period of time even though some of the gains will go to the lender. Finally, the lender needs to assure himself that the borrower will not simply disappear with the profits. Investment thus raises a series of problems that economists have classified as problems of “adverse selection” and “moral hazard.” Such problems arise wherever there is an “intertemporal” market, that is, a market in which exchanges occur in different time periods. Credit markets are intertemporal markets, as are social insurance markets, which we will encounter in Chapter 4. These problems are particularly difficult in international markets, because the information available about potential borrowers and investment projects in another country may be of low quality.

See Price system Marx, Karl, 26, 30, 39; proletarianization thesis of, 17–18 Maximin principle, of Rawls, 2, 35, 106 McGovern, George, 112 Means of production, collectivizing of, 39, 62, 63–64 Minimum wage: EITC and, 109; health insurance and, 103; monopsony power of employers, 96; raising of, and effect on level of employment, 95–96; redistribution and, 75, 94; unions and, 91; in US and France, 50, 110–111, 117; wage distribution and, 8 Monopoly power, of unions, 89, 94 Monopsony power, of employers, 94–96, 113–114, 121 Moral hazard, credit markets and, 60–61 Murray, Charles, 82, 87 Negative income tax, 1, 3, 112–113 Nonwage compensation, 6t, 8, 12, 13. See also Self-employment compensation Norway: historical evolution of inequality, 22; income inequality, 14; wage inequality, 10 OECD countries: evolution of shares of profits and wages, 49–53, 50t; historical evolution of inequality, 21; income inequality, 14–15, 15t; wage inequality, 10–11, 11t Panel Study of Income Dynamics (PSID), 83 Pareto efficiency, 2–3, 57, 79 Part-time work, income inequality and, 25 Pay-as-you-go (PAYGO) pension systems, 117–118 Payroll taxes.


pages: 160 words: 53,435

Good Prose: The Art of Nonfiction by Tracy Kidder, Richard Todd

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Atul Gawande, demand response, In Cold Blood by Truman Capote, moral hazard, Ralph Waldo Emerson, The Bell Curve by Richard Herrnstein and Charles Murray, Yogi Berra

The argument against such prose is that it enacts not egotism but egocentrism, the placing of oneself at the center of the universe. But that follows in the great tradition of essay writing. In the essay, one steps forward. Even in the rare case where the first person doesn’t appear, an individual authority is summoned, as in the magisterial critical essays of T. S. Eliot. The self as the measure of all things has its moral hazards, but the essayist needs at least a dash of Emersonian confidence, and more than a dash is useful to some. The essayist can also appear as a figure who boasts of little in the way of heightened emotion or peculiarity of feeling. This sort of writer’s whole claim on the reader is the claim of the norm: I am but a distillation of you. E. B. White achieves such a presence. His essays, though rooted in midcentury America, travel well through time.

Malcolm argues that something dishonest tends to lurk in all relationships between authors and their subjects. Certainly, all such relationships contain competing narratives. The subject has a story, the writer has a story, and the two don’t coincide exactly. They may diverge radically. Writer and subject each want something from the other. So what? Life is full of people with varied interests striking a deal. But a special moral hazard arises in the journalistic case, in the multiple opportunities for deception and in the imbalance of power. The relationship between subject and author, according to Malcolm, often amounts to a mutual seduction, in which the journalist inevitably occupies the stronger position: “The moral ambiguity of journalism lies not in its texts but in the relationships out of which they arise—relationships that are invariably and inescapably lopsided.”


pages: 353 words: 81,436

Buying Time: The Delayed Crisis of Democratic Capitalism by Wolfgang Streeck

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banking crisis, Bretton Woods, capital controls, Carmen Reinhart, central bank independence, collective bargaining, corporate governance, David Graeber, deindustrialization, Deng Xiaoping, Eugene Fama: efficient market hypothesis, financial deregulation, financial repression, full employment, Gini coefficient, Growth in a Time of Debt, income inequality, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, labour market flexibility, labour mobility, late capitalism, means of production, moral hazard, Occupy movement, open borders, open economy, Plutonomy: Buying Luxury, Explaining Global Imbalances, profit maximization, risk tolerance, shareholder value, too big to fail, union organizing, winner-take-all economy, Wolfgang Streeck

Be that as it may, from the point of view of market justice there is a constant danger that ideas of social justice will usurp the public power through the formation of a democratic majority and then regularly distort the operation of the market. Social justice is material, not formal, in nature – and so it cannot but appear irrational, arbitrary and unpredictable in terms of the formal rationality of the market.25 Politics, to the extent that it is driven by demands for social justice, therefore confuses the market process, muddies its outcomes, creates false incentives and ‘moral hazards’, undermines the performance principle and is generally alien to the ‘business world’. On the other hand, from the point of view of social justice, the ‘democratic class struggle’26 is an indispensable corrective in a system which, resting upon unequal contracts between wage-earners and profit-makers, gives rise to a cumulative advantage in line with what has been called the Matthew principle: ‘For to all those who have, more will be given, and they will have an abundance; but from those who have nothing, even what they have will be taken away’ (Matt. 25:29).

Of course, a country’s debts are always financed or refinanced in tranches, so that it takes a while before an increase in interest rate applies to such a large part of its total debt that the possibility of a default becomes acute. It cannot be in the creditors’ interest to see that situation arise, since it would kill the goose that lays their golden egg – unless, of course, they can count on another stepping into the breach. Obviously this would create a ‘moral hazard’ if ever there was one. 78 To be sure, one does not know exactly how the financial institutions of various countries are intertwined with one another. So-called stress tests, precisely if administered by international organizations, may tell us nothing about this: first, because they can only use data collected and passed on by national supervisory bodies; and second, because they have to be organized in such a way that, even in the worst of cases, their results do not cause panic. 79 For more on this, see the discussion in Chapter 3 on the European Union as an international ‘consolidation state’. 80 In the social sciences, this perspective is cultivated by comparative policy research that nearly always has agonistic undertones.


pages: 586 words: 159,901

Wall Street: How It Works And for Whom by Doug Henwood

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accounting loophole / creative accounting, affirmative action, Andrei Shleifer, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, borderless world, Bretton Woods, British Empire, capital asset pricing model, capital controls, central bank independence, corporate governance, correlation coefficient, correlation does not imply causation, credit crunch, currency manipulation / currency intervention, David Ricardo: comparative advantage, debt deflation, declining real wages, deindustrialization, dematerialisation, diversification, diversified portfolio, Donald Trump, equity premium, Eugene Fama: efficient market hypothesis, experimental subject, facts on the ground, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, George Akerlof, George Gilder, hiring and firing, Hyman Minsky, implied volatility, index arbitrage, index fund, interest rate swap, Internet Archive, invisible hand, Isaac Newton, joint-stock company, Joseph Schumpeter, kremlinology, labor-force participation, late capitalism, law of one price, liquidationism / Banker’s doctrine / the Treasury view, London Interbank Offered Rate, Louis Bachelier, market bubble, Mexican peso crisis / tequila crisis, microcredit, minimum wage unemployment, moral hazard, mortgage debt, mortgage tax deduction, oil shock, payday loans, pension reform, Plutocrats, plutocrats, price mechanism, price stability, prisoner's dilemma, profit maximization, Ralph Nader, random walk, reserve currency, Richard Thaler, risk tolerance, Robert Gordon, Robert Shiller, Robert Shiller, shareholder value, short selling, Slavoj Žižek, South Sea Bubble, The Market for Lemons, The Nature of the Firm, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, transcontinental railway, women in the workforce, yield curve, zero-coupon bond

Hot for funds to get into these pursuits, and subsequently hotter for funds to cover losses, thrifts pushed up interest rates to attract deposits from Wall Street. It used to be said that nobody got rich in the thrift industry and nobody went bust; during the freeplay of the 1980s, people did both. Conservatives love to point to the web of perverse incentives that spaw^ned the affair. Deposit insurance removed all incentive for depositors to scrutinize the thrift's portfolio (a situation bankers and their friends call "moral hazard"). The mutual structure reinforced this, since individual depositor-shareholders have neither time nor interest nor expertise to scrutinize management. Abolish deposit insurance, said the right radicals, or rein it in, said the centrists. Of course, without deposit insurance, the entire financial system would probably have collapsed in a climactic run sometime between 1987 and 1990. If you're going to insure deposits, you'd better supervise bankers pretty closely; the price of the S&L bailout would have funded the presence of 10 full-time bank examiners in ever>' thrift in the country for close to 200 years.

One of the crucial junk bond buyers in Michael Milken's network was a public thrift, Columbia Savings. Shareholders can be as dispersed and inattentive as small depositors. Economists have their own understanding. Thrift pundit Robert Litan (1992) rejected popular explanations of the crisis, which center on "venality, greed and incompetence," out of professional discomfort. Instead, Litan preferred the terrain of conventional economics — inflation, interest rate volatility, moral hazard, real estate slump, and the rest — and, like a loyal economist, was eager to get deregulation off the hook. PLAYERS Of course inflation and the rest are to blame. But it would be impoverishing to stop there. Litan's fellow economists assured us that financial deregulation was supposed to release untold energies by liberating the self-adjusting mechanisms of the capital markets. Instead, it released imprudence, incompetence, and fraud throughout the entire system.

Michael, 311 monetarism, 137, 191, 199-202 empirical record, 201-202, 242 part of the apparatus of crackdown, 201 ■Volcker's faux, 201 Walters' outburst, 242 monetary crank, 2^3 monetary policy, q theory and, 144-145; see also central banks; Federal Reserve monetary theory of production, 199, 231 money coercive aspects, 232 and crisis Keynes, 202-205 Marx, 232-236 definitions, 191 economists' treatment of, 10 endogenous, 200, 217-221 Marx on, 220-221 political implications, 220 see also post-Keynesianism exogenous, 217 face of the boss, 301 vs. finance, 183 in formation of capitalism as system, 245 as general wealth (Marx), 233 as a kind of poetry, 224 local, 302 neutrality of. 137 classical position, 199 and Greenspan, 158 how finance matters, 153-161 origin of term, 199 as object of greed, 236 political struggle over definition, 93-94 and power, 11 psychology of, 224—229 anal roots, 225-226 ascetic cultism, 224-225 interest rate effects on sentiment, 119 Marx and, 236-237 mob psychology, 176-177, 185 goldbugs, 244 refusing, 320 reticence about, 52 rule of, 232 ending, 321 smart vs. dumb, 53 as social bond (Marx), 231 ultimately a state thing, 232 velocity of, 191 money-center banks, 82 money managers damning self-evaluation, 291 get others to save for them, 239 poor performance of, 3, 165 Monks, Robert, 293, 299 Monthly Review. 230, 261 Moore, Basil, 218 moral hazard, 88 moralizing, 70 Morgan,J.P.,82, 93, 260 Morgan 0?) Bank, 262, 265, 277 Morgan Stanley, 83, 263, 271 mortgage debt, 63 Mullin.John, 125 Municipal Assistance Corp., 295 municipal bonds, 26-27 mutual funds, 7, 84 gain in market share, 81 shyness in governance issues, 291 mutual savings banks, 86 naked shorts, 31 Nasdaq, 12, 19-22 hires Nobelist to defend itself, 182 National As.sociation of Community Development Loan Funds, 312 National Association of Securities Dealers (NASD), 19; see also Nasdaq National City Bank of New 'Vork, 261; see also Citibank national income and product accounts (NIPA), 56, 189-190 "natural" in social sciences, 242 nature, costs of LBOs to, 274 necessitous borrowing, 65 Neff.


pages: 471 words: 124,585

The Ascent of Money: A Financial History of the World by Niall Ferguson

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Admiral Zheng, Andrei Shleifer, Asian financial crisis, asset allocation, asset-backed security, Atahualpa, bank run, banking crisis, banks create money, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, BRICs, British Empire, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, collateralized debt obligation, colonial exploitation, Corn Laws, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, deglobalization, diversification, diversified portfolio, double entry bookkeeping, Edmond Halley, Edward Glaeser, Edward Lloyd's coffeehouse, financial innovation, financial intermediation, fixed income, floating exchange rates, Fractional reserve banking, Francisco Pizarro, full employment, German hyperinflation, Hernando de Soto, high net worth, hindsight bias, Home mortgage interest deduction, Hyman Minsky, income inequality, interest rate swap, Isaac Newton, iterative process, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, labour mobility, London Interbank Offered Rate, Long Term Capital Management, market bubble, market fundamentalism, means of production, Mikhail Gorbachev, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, mortgage tax deduction, Naomi Klein, Nick Leeson, Northern Rock, pension reform, price anchoring, price stability, principal–agent problem, probability theory / Blaise Pascal / Pierre de Fermat, profit motive, quantitative hedge fund, RAND corporation, random walk, rent control, rent-seeking, reserve currency, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, seigniorage, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spice trade, structural adjustment programs, technology bubble, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Malthus, Thorstein Veblen, too big to fail, transaction costs, value at risk, Washington Consensus, Yom Kippur War

Yet all their deposits were still effectively insured, with the maximum covered amount raised from $40,000 to $100,000. And, if ordinary deposits did not suffice, the S&Ls could raise money in the form of brokered deposits from middlemen, who packaged and sold ‘jumbo’ $100,000 certificates of deposit.39 Suddenly the people running Savings and Loans had nothing to lose - a clear case of what economists call moral hazard.40 What happened next perfectly illustrated the great financial precept first enunciated by William Crawford, the Commissioner of the California Department of Savings and Loans: ‘The best way to rob a bank is to own one.’41 Some S&Ls bet their depositors’ money on highly dubious projects. Many simply stole it, as if deregulation meant that the law no longer applied to them. Nowhere were these practices more rife than in Texas.

Companies in non-financial industries are seen as less systemically important to the economy as a whole and less critical to the livelihood of the consumer. The collapse of a major financial institution, in which retail customers lose their deposits, is therefore an event which any regulator (and politician) wishes to avoid at all costs. An old question that has raised its head since August 2007 is how far implicit guarantees to bail out banks create a problem of moral hazard, encouraging excessive risk-taking on the assumption that the state will intervene to avert illiquidity and even insolvency if an institution is considered too big to fail - meaning too politically sensitive or too likely to bring a lot of other firms down with it. From an evolutionary perspective, however, the problem looks slightly different. It may, in fact, be undesirable to have any institutions in the category of ‘too big to fail’, because without occasional bouts of creative destruction the evolutionary process will be thwarted.

Marshall Plan 305-7 Martin, William McChesney Jr 168 Marx, Groucho 161 Marx, Karl/ Marxism 17 Marylebone Workhouse 199-203 Mary Poppins 7 Massachusetts Affordable Housing Alliance 266 Massys, Quentin 43 Masulipatnam 130 mathematics: applied to finance and insurance 3 Chinese 32 history of 30-32 Oriental 3 Matheson, James 289-92 Medicare and Medicaid 211 Medici family 3 diversification 44-6 libro segreto 44-5 Medici, Cosimo (C15) 42 Medici, Duke Cosimo de’ (C16) 41 Medici, Giovanni di Bicci de’ 42 Medici, Lorenzo the Magnificent 46-7 Mediterranean 24-5 Memphis 59-60 mercenaries 69-71 merchant banks 53 Merchant of Venice see Shakespeare, William mergers and acquisitions 351 Meriwether, John 322 Merrill Lynch 272 Merton, Robert 320 Mesopotamia/Babylonia 27-31 metals, link with money 1 Mexico 25 Miami 264 Michelet, Jules 90 micro-businesses 280 microfinance 13 Middle East 135 sovereign wealth funds 9 war in 6 migration 286 Milan 70 millionaires 146 Minsky, Hyman 164 MIRAS see Mortgate Interest Relief At Source misconduct see fraud Mishkin, Frederic 342 Mississippi 90. see also bubbles; Katrina Mississippi Company (former Company of the Indies, Compagnie des Indes) 142-57 Mohamad, Mahathir bin 314 Moivre, Abraham de 189 Moluccas 130-31 monarchs see royal funding monetary policy: and decline in asset prices 163 and domestic objectives 306-7 and mortgage crisis 266 transformation of 116 monetary theory 100-101 money: criteria for 23-4 driving force behind progress 342 as god 85 market 54 potential excess of 64 prejudices against 1-2 as representation of: belief and trust 29-30; commoditized labour 17; relationship between debtor and creditor 341 tokens as 27 as total of specific liabilities incurred by banks 51 see also coins; electronic money; paper money moneylenders: hostility to 2 illegal see loan sharks vulnerability to defaults 37-8 moneyless societies 17-19 money supply: definitions 50-51 increasing 26 and war 100 ‘mono-line’ financial services 353 monopolies 135 Monopoly (game) 230-32 Montagu, Lady Mary Wortley 146 Moody’s 268 Moore, Deborah 196n. moral hazard 255 Morgan (J. P.) 326n. Morgan Stanley 337. Morocco 297 mortality statistics 188. see also life expectancy Mortgage Interest Relief At Source (MIRAS) 252 mortgages 8-9 adjustable-rate (ARMs) 264 discrimination in 248-51 and economic downturns 8 federal government and 247 fixed-rate residential 264 foreclosures 242 in Great Depression/New Deal 247 history 8-9 indebtedness 61 ‘no recourse’ 270n.


pages: 385 words: 128,358

Inside the House of Money: Top Hedge Fund Traders on Profiting in a Global Market by Steven Drobny

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Albert Einstein, asset allocation, Berlin Wall, Bonfire of the Vanities, Bretton Woods, buy low sell high, capital controls, central bank independence, Chance favours the prepared mind, commodity trading advisor, corporate governance, correlation coefficient, Credit Default Swap, diversification, diversified portfolio, family office, fixed income, glass ceiling, high batting average, implied volatility, index fund, inflation targeting, interest rate derivative, inventory management, Long Term Capital Management, margin call, market bubble, Maui Hawaii, Mexican peso crisis / tequila crisis, moral hazard, new economy, Nick Leeson, oil shale / tar sands, oil shock, out of africa, paper trading, Peter Thiel, price anchoring, purchasing power parity, reserve currency, risk tolerance, risk-adjusted returns, risk/return, rolodex, Sharpe ratio, short selling, Silicon Valley, The Wisdom of Crowds, too big to fail, transaction costs, value at risk, yield curve, zero-coupon bond

They have nearly always been wrong. I mean, remember they are bureaucrats. If they could get a real job, they would not be working for the government. Look at Greenspan, he is a bureaucrat. He has failed at everything he has done.That is why he kept trying to get government jobs. Look at his career history and look at his history as a central banker—it is a mess. Is moral hazard one of the biggest problems in the world right now? I do not sit around worrying about moral hazard but it is always a mistake to bail people out. Look at the Japanese—they have been bailing out their people for 14 years and supporting zombie companies. If they had just let them collapse, Japan would have been a great success story the past 10 years. 230 INSIDE THE HOUSE OF MONEY It is interesting that Greenspan is always going on the circuit saying to the Japanese, “Why don’t you clean out your system?

See also Deutsche mark; Swiss franc Mark-to-market, 25, 133, 137, 140 Martin,William McChesney, 13 Maslow,Abraham, 264 Maslow’s Hierarchy of Needs, 264–265 Mean reversion, 69, 112, 258 Mergers and acquisitions, 24 Meriwether, John, 24, 158 Merton, Robert, 24 Metals, 257 Mexico/Mexican peso, 39, 204, 210, 261, 286–287, 290, 296 Microeconomics, 257 Micromanagement, 32, 52, 60 Microsoft, 59 MinFin, 293 Minimum funding requirements (MFR), 136 Mining, 252 Misalignments, 174 Mispricings, 63, 335 Modern portfolio theory, 232 Mohamad, Mahathir, 20 Monetary policy, 168–169, 327 Money management, 185 Money Masters (Train), 244 Money supply, 93 Mongolia, 261, 289, 306 Moore Capital Management, 134–135, 144, 154–155 Moral hazard, 229–230 Mraz, Jason, 241 MSCI Emerging Markets Eastern Europe, 299 Mullins, David, 24 Multibet portfolio approach, 343–344 Multistrategy hedge fund, 33 Multiyear lockups, 69 Mutual funds, 53, 143, 219–220, 300 NAFTA, 287 NASDAQ, 27–28, 54, 144, 146, 227, 254, 277, 279, 291 National Bureau of Economic Research (NBER), 62 National Health Service (United Kingdom), 61 Natural disasters, economic impact of, 296–297, 349 Natural gas, 256, 263 Negative gamma, 330, 336 Net asset value (NAV), 58, 95, 137, 283 Netherlands, 68, 111 Neuberger, Roy, 233 New economy, 27 Newsletters, 104, 119–120, 130 New Zealand/New Zealand dollar, 66, 151, 167–168, 193 Nicholas, Joseph G., ix, xiv Nifty Fifty, 29 Nigeria, 60 Nixon Administration, 7 Nonprice indicators, 192 Normal distribution, 343–344 North Korea, 305 Nuclear war, 44 “Off the run” bonds, 24 Oil, 166, 193, 219, 230–231, 235, 237, 239, 252, 256, 280 Old economy, 27 Olink, Glen, 9 1-percent-a-month strategy, 292 “On the run” bonds, 24 Open-ended trends, 258 Optimistic traders, 112–113, 272 Option(s), 11, 24, 45, 85, 127, 177, 207, 331–332.

Falling Behind: Explaining the Development Gap Between Latin America and the United States by Francis Fukuyama

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Andrei Shleifer, Atahualpa, barriers to entry, Berlin Wall, British Empire, business climate, Cass Sunstein, central bank independence, collective bargaining, colonial rule, conceptual framework, crony capitalism, European colonialism, Fall of the Berlin Wall, first-past-the-post, Francis Fukuyama: the end of history, Francisco Pizarro, Hernando de Soto, income inequality, income per capita, labour market flexibility, land reform, land tenure, Monroe Doctrine, moral hazard, New Urbanism, oil shock, open economy, purchasing power parity, rent-seeking, Ronald Reagan, The Wealth of Nations by Adam Smith, total factor productivity, trade liberalization, transaction costs, upwardly mobile, Washington Consensus

As Dani Rodrik has phrased it: “the question before policymakers . . . is no longer do institutions matter, but which institutions matter and how does one acquire them?”32 Rodrik sets out a cogent agenda for state reform, and he states that institutions must facilitate the development and consolidation of a clearly designated system of property rights, a regulatory apparatus curbing the worst forms of fraud, anti-competitive behavior and moral hazard, a moderately cohesive society exhibiting trust and social cooperation, social and political institutions that mitigate risks and manage social conflicts, the rule of law and clean government.33 The challenge is enormous. But Latin American leaders need to assume the responsibility of creating smart states or run the risk of continued discontent and resentment by their citizens at their failure to produce growth and improve equity.

From this perspective, and as we explained in the previous section, even though there has been dramatic institutional change in Latin America since 1982, characterized by transitions from authoritarian to democratic rule and from relatively closed, state-led economies to open, market-driven economies, weak states whose jurisdiction and enforcement capacities have remained weak and open to traditional capacity-draining activities, such as rent seeking and moral hazard, have helped to reproduce the conditions that allow the survival and growth of high-stakes politics. To this element, we have to add others, namely, the persistence of dramatic socioeconomic inequality and widespread poverty, which have nurtured the zero-sum conditions that allow high-stakes politics to thrive and dominate in Latin America at the beginning of the twenty-first century. The Need to Have a Social Contract: Addressing Poverty and Inequality in Latin America The theme is constant in the literature on Latin America.

In many ways, the Reagan and Thatcher revolutions, which sought to cut back the scope of the state, occurred because the modern welfare state had become too large and dysfunctional. Europe today is facing a looming crisis of competitiveness because its labor markets are encumbered with regulations designed to protect workers but whose actual effect is to raise levels of unemployment. Transfer payments and subsidies come to be seen as entitlements; they create moral hazards and disincentives to work. What is true for wealthy countries in Western Europe is doubly so for poorer countries like Brazil and Argentina, which tried to implement European-style worker protections back in the 1940s and 1950s, when they were at a much lower level of development. Part of the overbuilt state that neoliberal reformers were trying to dismantle consisted precisely of social welfare programs that had become excessively expensive and/or counterproductive.

Investment: A History by Norton Reamer, Jesse Downing

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Albert Einstein, algorithmic trading, asset allocation, backtesting, banking crisis, Berlin Wall, Bernie Madoff, Brownian motion, buttonwood tree, California gold rush, capital asset pricing model, Carmen Reinhart, carried interest, colonial rule, credit crunch, Credit Default Swap, Daniel Kahneman / Amos Tversky, debt deflation, discounted cash flows, diversified portfolio, equity premium, estate planning, Eugene Fama: efficient market hypothesis, Fall of the Berlin Wall, family office, Fellow of the Royal Society, financial innovation, fixed income, Gordon Gekko, Henri Poincaré, high net worth, index fund, interest rate swap, invention of the telegraph, James Hargreaves, James Watt: steam engine, joint-stock company, Kenneth Rogoff, labor-force participation, land tenure, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, margin call, means of production, Menlo Park, merger arbitrage, moral hazard, mortgage debt, Network effects, new economy, Nick Leeson, Own Your Own Home, pension reform, Ponzi scheme, price mechanism, principal–agent problem, profit maximization, quantitative easing, RAND corporation, random walk, Renaissance Technologies, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Sand Hill Road, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spinning jenny, statistical arbitrage, technology bubble, The Wealth of Nations by Adam Smith, time value of money, too big to fail, transaction costs, underbanked, Vanguard fund, working poor, yield curve

The ultimate effect of the bank bailouts during the Great Recession has been to introduce an essential and oft-discussed question: have banks become too big to fail? The concept of too big to fail is problematic for two reasons. The first is that if true, moral hazard may arise whereby exceptionally large institutions take on more risk than is prudent, thinking there will be a bailout in case the risk taking results in outsized losses. In particular, has the offering of bank bailouts to exceptionally large institutions altered their behavior in a way that has created moral hazard? Will banks now engage in risky practices in the belief that their risk is now limited by the federal government’s safety net? The second reason is that a bank bailout can create an unfair divergence in capital access between small and large institutions.

., 214 Mises, Ludwig von, 205 Mitchell, Charles, 164 Mit Ghamr Savings Bank, 38 Modigliani, Franco, 121–22, 233 Moley, Raymond, 211 momentum investing strategies, 314 monetarist school, 206–7, 212 428 Investment: A History Monetary History of the United States, 1867–1960, A (Friedman and Schwartz), 206 money: Aristotle on, 33, 59; expanding supply of, 176; sterility of, 23; time value of, 32 moneylenders (doso), 31 money market mutual funds, 143 Monte, 83 moral hazard, 219 Mores, Edward Rowe, 132 Morgan Stanley, 294 Morgenthau, Henry, 209–10 mortality risk, 132, 145 mortgages, 321–23; insurance, 321; mortgage-backed securities, 217, 266, 323; mortgage debt, highly rated tranches of, 224; subprime-mortgage lending, 223 mudaraba contract, 35, 53, 55 mufawada contract, 55 Muhammad, 37 Murlyn Corporation, 190 Murphy, Thomas, 7 Muscovy Company, 65–66 musharaka contract, 53 Muth, Richard, 207 mutual funds, 139–44; closedend, 140, 141; 401(k) and, 144; Great Depression and open-ended, 141–42; industry today, 144; money market, 143; opportunities with, 92; during postwar period, 142–44; precursors to, 140; in retirement accounts, 295; shares through, 93 mutual life insurance companies, 133–34 mutual savings banks, 134–37 Napoleon, 74 Napoleonic Wars, 87 naruqqum investment partnerships, 52 Nasser Social Bank, 38 National Conference of Commissioners on Uniform State Laws, 124 National Housing Act of 1934, 321–22 national or international exchange, 94 National School Lunch Program, 167 National Venture Capital Association (NVCA), 278 Natomas Company, 186 natural catastrophe, 332; raising funds by selling, 162; “safe,” 1; selling and purchasing, 165; Treasury, 252 natural resources, commodities and, 281–82 NBC Reports, 111 Needham & Co., 187 negotiable bills of exchange, 83–84 nemulum (net profit), 52 net present value (NPV), 231–32 net profit (nemulum), 52 new asset classes, 331–32 New Deal, 92, 108, 109 new elite, 10, 291, 304–5, 315, 318 New World, 65, 69 New York Curb Market Agency, 89, 97 New York Life, 102 New York Stock Exchange (NYSE), 88, 191; closure of, 203; mergers and transformations, 95; “Own Your Share of American Business” campaign, 92; stock ticker network, 95; trading Index 429 volume, 89, 90; Whitney, R., and, 164–67 New York Stock Exchange Gratuity Fund, 165 New York Yacht Club, 165 Nicostratus, 24 no-arbitrage condition, 235–36 Nomos Nautikos, 52 nonnegotiable bills of exchange, 83 Norman, Montagu, 202 Nourse, Edwin, 207 NPV.

Making Globalization Work by Joseph E. Stiglitz

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affirmative action, Andrei Shleifer, Asian financial crisis, banking crisis, barriers to entry, Berlin Wall, business process, capital controls, central bank independence, corporate governance, corporate social responsibility, currency manipulation / currency intervention, Doha Development Round, Exxon Valdez, Fall of the Berlin Wall, Firefox, full employment, Gini coefficient, global reserve currency, happiness index / gross national happiness, illegal immigration, income inequality, income per capita, incomplete markets, Indoor air pollution, informal economy, inventory management, invisible hand, Kenneth Rogoff, low skilled workers, manufacturing employment, market fundamentalism, Martin Wolf, microcredit, moral hazard, North Sea oil, offshore financial centre, oil rush, open borders, open economy, price stability, profit maximization, purchasing power parity, quantitative trading / quantitative finance, race to the bottom, reserve currency, rising living standards, risk tolerance, Silicon Valley, special drawing rights, statistical model, the market place, The Wealth of Nations by Adam Smith, Thomas L Friedman, trade liberalization, trickle-down economics, union organizing, Washington Consensus

In both East Asia and Latin America, bail-outs provided money to repay foreign creditors, thus absolving creditors from having to bear the costs of their mistaken lending. In some instances, governments even assumed private liabilities, effectively socializing private risk. The creditors were let off the hook, but the IMF's money wasn't a gift, just another loan—and the developing country was left to pay the bill. In effect, the poor country's taxpayers paid for the rich country's lending mistakes. The bail-outs give rise to the famous "moral hazard" problem. Moral hazard arises when a party does not bear all the risks associated with his action and as a result does not do everything he can to avoid the risk. The term originates in the insurance literature; it was deemed immoral for an individual to take less care in preventing a fire simply because he had insurance coverage. It is, of course, simply a matter of incentives: those with insurance may not set their houses on fire deliberately, but their incentive to avoid a fire is still weakened.

Gregory, 270 manufacturing, xi, 25, 32, 77 maquiladora factories, 65 market economy, xi-xii, xiii, 273, 277 according to Smith, 189-90 forms of, xv, 9-10 managed, 26-27 unemployment and, 273 market efficiency, x market failures, 190, 296n-97n market fundamentalism, xiii, xiv, 29-30, 35, 48, 293n markets, 47 balance between government and, xv 351 as center of successful economy, 27 economic efficiencies and, xiii, xiv, xvi, 29 as factor in growth, 48 limitations of, xii, xiv undermined by extensive patents, 109 Marshall, Alfred, 326n materialism, 188-89 mathematics, patents and, 113-14 Mauritania, 331n Mauritius, 303n Maximilian, Archduke of Austria, 214 Medicare drug benefits, 191 Menem, Carlos, 221 Mengistu Haile Mariam, 229 Metaclad, 130 "me-too" drugs, 313n, 317n Mexico, 6, 46, 91, 92, 134, 152, 214, 308n air pollution in, 164 economic crisis of, 233 employment in, 65 growth in, 64 NAFTA and, 61-62, 64-66, 197, 285, 300n, 301n, 302n remittances to, 89 tomato exports from, 64-65 wages in, 65 micro-loans, 51-53 Microsoft, 58, 109, 111, 112, 191, 202-3, 279, 312n-13n Middle East, 104, 134, 136, 137 Millennium Development Goals, 14, 249, 267, 295n, 336n Millennium Summit, 14, 99 mining industry, 141, 143, 194, 195, 199, 206 Mkapa, Benjamin W, 8, 41 Mobutu Sese Seko, 136, 229 Moldova, 40, 211, 212, 218, 225, 227 Mongolia, 40 monopolies, 58, 92, 311n and economic inefficiency, 107-8 enforcement of competition policy on, 204 global approach needed for, 201, 202-3 globalization of, 200-203 as greater threat to development than developed nations, 119 innovation reduced by, 109, 202 legal oversight of, 200, 201, 202-3 of prices in pharmaceutical industry, 120 technology and, 58 Monsanto, 187 Monterrey, Mexico, 99, 287 352 INDEX Monti, Mario, 201 Montreal Protocol (1987), 168, 176 "moral hazard" problem, 217 morality, as irrelevant in Smith an economics, 189-90 Morocco, 97, 103-4, 130, 310n most favored nation principle, 75, 82 Mozambique, 331 n Mozilla Firefox, 112, 314n multifiber agreement, 305n multinational corporations, see corporations Mumbai, India, 3, 6-7, 275 Museveni, Yoweri, 41 Myrdal, Gunnar, 30 Myriad, 114, 314n Napoleon III, Emperor of France, 214 National Institutes of Health, 113-14, 317n nation-state, 19-24 natural resources, 149, 153 managing use of, 54-55 see also resource-rich countries; specific resources Nayaar, Deepak, 4 neem tree, 126-27 Nestle, 187 Netherlands, 111, 139, 148, 295n Netscape, 58, 109, 202, 314n networking, 5 new drug applications (NDAs), 313n Newfoundland, 214 New Zealand, 78, 93, 319n Nicaragua, 307n, 331n Niger, 331n Nigeria, 40, 41, 55, 136, 148, 198, 320n, 324n debt of, 229, 234-35 oil in, 134, 135, 146 Nike, 198 Nobel, Alfred, 133 Nobel Prize, x, xii nonagricultural market access (NAMA), 307n nonmarket economies, 92 nontariff barriers, 64, 90-96, 129-31 North American Free Trade Agreement (NAFTA), 61-62, 64-66, 76, 130-31, 197, 270, 285, 300n, 301n, 302n North Korea, 178 Norway, 85, 91, 149-50, 169, 295n Novartis, 127, 318n nuclear proliferation, 266. 325n odious debt, 228-31, 241, 242, 331n Office of Science and Technology Policy, 116 Office of the U.S.


pages: 540 words: 168,921

The Relentless Revolution: A History of Capitalism by Joyce Appleby

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1919 Motor Transport Corps convoy, agricultural Revolution, anti-communist, Asian financial crisis, asset-backed security, Bartolomé de las Casas, Bernie Madoff, Bretton Woods, BRICs, British Empire, call centre, collateralized debt obligation, collective bargaining, Columbian Exchange, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, deskilling, Doha Development Round, double entry bookkeeping, epigenetics, equal pay for equal work, European colonialism, facts on the ground, failed state, Firefox, Ford paid five dollars a day, Francisco Pizarro, Frederick Winslow Taylor, full employment, Gordon Gekko, Henry Ford's grandson gave labor union leader Walter Reuther a tour of the company’s new, automated factory…, Hernando de Soto, hiring and firing, illegal immigration, informal economy, interchangeable parts, interest rate swap, invention of movable type, invention of the printing press, invention of the steam engine, invisible hand, Isaac Newton, James Hargreaves, James Watt: steam engine, Jeff Bezos, joint-stock company, Joseph Schumpeter, knowledge economy, land reform, Livingstone, I presume, Long Term Capital Management, Mahatma Gandhi, Martin Wolf, moral hazard, Ponzi scheme, profit maximization, profit motive, race to the bottom, Ralph Nader, refrigerator car, Ronald Reagan, Scramble for Africa, Silicon Valley, Silicon Valley startup, South China Sea, South Sea Bubble, special economic zone, spice trade, spinning jenny, strikebreaker, the built environment, The Wealth of Nations by Adam Smith, Thomas L Friedman, Thorstein Veblen, total factor productivity, trade route, transatlantic slave trade, transatlantic slave trade, transcontinental railway, union organizing, Unsafe at Any Speed, Upton Sinclair, urban renewal, War on Poverty, working poor, Works Progress Administration, Yogi Berra, Yom Kippur War

To stress the point, IBM described its “holistic management approach that promotes business effectiveness and efficiency while striving for innovation, flexibility and integration with technology.”17 But intelligence and communication are not enough, as the recent financial fiasco demonstrated. Wisdom is required too. Economists are now talking about something called moral hazard, a term that refers to the dangers of giving people the wrong incentives. It’s a moral hazard for the government to bail out banks because bankers in the future will take foolish risks if they conclude that they will not have to pay for them. It’s reminiscent of the expert who claimed that “capitalism without bankruptcy is like Christianity without hell.”18 A systematic means of controlling sin apparently is as necessary in economics as it is in religion. The phrase “moral hazard” itself suggests that market participants now realize that capitalism has an essential underpinning in social norms. People may say that virtue is its own reward, but most of us find that an insufficient return.

We didn’t see this for a long time because we as a society have been committed to the moral benefit of hard work. Only recently has an ethic of pleasure seeking become prevalent. And that’s the problem. The free enterprise economy depends upon competition, sensible choices, and widely shared information, even as it rewards people who corner a market, trick others into foolish bargains, and use secret information to their own advantage. It’s just possible that the real moral hazard today is that capitalism is battening off an older ethic taught by parents and teachers when there was an adult consensus about how to rear children to behave responsibly. If this set of values fades altogether, we will be bereft of the moral base of capitalism, which depends upon men and women’s meeting obligations, managing resources prudently, valuing hard work, and treating others fairly.


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The Bankers' New Clothes: What's Wrong With Banking and What to Do About It by Anat Admati, Martin Hellwig

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Andrei Shleifer, asset-backed security, bank run, banking crisis, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, bonus culture, Carmen Reinhart, central bank independence, centralized clearinghouse, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, diversified portfolio, en.wikipedia.org, Exxon Valdez, financial deregulation, financial innovation, financial intermediation, George Akerlof, Growth in a Time of Debt, income inequality, invisible hand, Jean Tirole, joint-stock company, joint-stock limited liability company, Kenneth Rogoff, London Interbank Offered Rate, Long Term Capital Management, margin call, Martin Wolf, moral hazard, mortgage debt, mortgage tax deduction, Nick Leeson, Northern Rock, open economy, peer-to-peer lending, regulatory arbitrage, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, shareholder value, sovereign wealth fund, technology bubble, The Market for Lemons, the payments system, too big to fail, Upton Sinclair, Yogi Berra

., 298n39 monetization, 322n32 money: banknotes as, history of, 149–50, 250n18, 293nn6–9; cartalist view of, 294n10, 294n14; of central banks, 151, 295n16; deposits treated as, 150, 293n10; liquidity provision and, 210; political impact of, 203, 325n48; purchasing power of, 157, 296n26, 297n37; quantity of, definitions of, 294n10 money creation (printing): electronic versus physical, 322n32; in euro area, 201; and inflation, 157–58, 276n6, 294n14, 295n16, 296n26, 297n37, 322n34; limitations on, 157–58; as “liquidity support,” 158; to pay sovereign debt, 102, 276n6, 322n32 money-like debt, 154–56, 160 money machine, 119, 281nn9–10; arbitrage opportunity as, 103, 276n9; bank borrowing from central banks as, 138; blanket guarantees as, 287n6, 291n30; zero-equity mortgages as, 136 money market, definition of, 48 money market funds (mutual funds): contagion in, 62–63; versus deposit institutions, 67, 309n47; deposit insurance for, lack of, 67, 93, 309n47; efforts to reform, 232n16, 259n30; European sovereign debt and, 170, 302n3; in financial crisis of 2007-2009, 62–63, 66, 138, 161; and French banks, 192; as funding source for banks, 48, 62–63, 67; guarantees for, 161; interconnectedness and, 66–67; interest rates of, 53–54, 67; legal definition of banks and, 309n47; Lehman bankruptcy and, 62–63, 66, 256n9, 309n47; liquidity narrative and, 330n12; mechanisms of, 67; as off-balance-sheet entities, 84; origins of, 53–54, 67, 251n27, 299n46, 335n53; reductions in lending by, 62–63; regulation of, 54, 67, 161, 251n27, 300n48, 309n47, 335n53; rise of, 66–67, 299n46; risks of, 299n46; runs on, 62–63, 67, 93, 161; in securitization of mortgages, 159–60; as shadow banking institutions, 225, 335n53 money view of banking, 250n18 Monopoly (game), 35 monopoly power: of banks, 249n12, 275n4; in telecommunications, 327n63 Moody’s Global Credit Division, 235n31 Moody’s Investors Services, 235n31 moral hazard. See incentives and moral hazard Morgan Stanley: change in status to bank holding company, 93, 138, 286n1; and knowledge about LIBOR scandal, 328n4; large trading losses of, 260n39; mistakes admitted by, 232n17 Morgenson, Gretchen, 234n27, 259n34, 300n47, 300n50, 325n49, 329n8, 331nn20–21, 332n28, 336n54 Morris, Charles S., 270n33, 333n40 Morris, Stephen, 330n17 mortgage(s), 18–24; adjustable-rate, 34, 160, 243n2, 298n44; in covered bonds, 254nn47–48, 298n41; creditworthiness assessments for, 56, 58, 248n9, 277n12; default on (See mortgage default); down payments and, 18–24, 22t; in financial crisis of 2007-2009, 59, 60–61, 65–66; financial distress and, 42–43, 246n18; guarantees on, impact of, 130–36, 132t, 134t, 142–43, 145–46, 287nn6–8; in home owner balance sheets, 18, 19f, 20, 20f, 23; interest payments on, 18–19, 21, 117–19, 140, 240n8, 289nn21–22; interest rates on, 34, 104, 105, 117, 160, 276n12, 280n6; leverage effect in, 19, 21–22, 107–8, 118–19; in liquidity transformation, 158–59; in maturity transformation, 158–59; nonrecourse clauses in, 21, 23, 240n5; prime, 254n43; problems caused by burden of, 33–34; return on equity in, 117–19, 118t, 135, 280n7, 287n7; risks of, 18–24, 102–3; second, 34, 44, 240n5, 247nn21–22, 286n5; securitization of (See securitization); solvency problems of S&Ls from, 54, 159, 252n32; subprime (See subprime mortgage(s)); tax subsidies for, 140, 289n22; underwater, 20–21, 42, 95, 133, 246n18; zero-equity, 135–36, 287–88nn8–9 mortgage-backed securities (MBS): breakdown of markets for, 58–59; in collateralized debt obligations, 255n2; versus covered bonds, 254nn47–48; definition of, 58; interconnectedness in, 68; as liquid assets, 272n44; in mortgage-related securities, 255n2; securitization of, 159, 255n2 mortgage default, 34, 243nn1–2; adjustable rates and, 34, 160, 243n2, 298n44; in financial crisis of 2007-2009, 211, 243n2; risk of, in costs of borrowing, 103, 105; securitization and, 58, 68, 254n43; in UK, 34, 243n1; in United States, 34.

Fahlenbrach, Rüdiger, and René Stulz. 2011. “Bank CEO Incentives and the Credit Crisis.” Journal of Financial Economics 99: 11–26. Farber, David B., Marilyn F. Johnson, and Kathy R. Petroni. 2007. “Congressional Intervention in the Standard-Setting Process: An Analysis of the Stock Option Accounting Reform Act of 2004.” Accounting Horizons 21 (1): 1–22. Farhi, Emmanuel, and Jean Tirole. 2011. “Collective Moral Hazard, Maturity Mismatch, and Systemic Bailouts.” Working paper. Harvard University, Cambridge, MA, and Toulouse School of Economics, University of Toulouse, Toulouse, France. FCIC (Financial Crisis Inquiry Commission). 2011. The Financial Crisis Inquiry Report. Washington, DC: U.S. Government Printing Office. Federal Reserve Bank of Dallas. 2012. “Choosing the Road to Prosperity: Why We Must End Too Big to Fail Now.” 2011 annual report.

See International Monetary Fund implicit guarantees and subsidies, 136–39; bankers’ claims about, 235n30; from central banks, in bank borrowing, 137–38; and concentration in banking, 89, 144, 290nn28–29; and credit ratings, 235n32, 291n33; in financial crisis of 2007-2009, 137–38; funding costs affected by, 137–38, 140–42, 290n29; perverse incentives from, 130, 139, 142–45, 198; as unlimited, 129, 137 incentives and moral hazard: in bank borrowing, 129, 130, 142–45, 220; for becoming too big to fail, 130, 142–45, 218; in bonuses, 162; in capital regulation, 95; career concerns and, 127, 228, 319n9; in compensation, 116, 122–27, 283n21, 284n24, 284n27; and corporate governance, 277n13; in creditworthiness assessments, 56, 58; in debt overhang, 130, 162–63; in evaluation of insolvency, 41; gambling for resurrection, 33, 54–55; induced by guarantees, 130, 139, 142–45, 198; for lending versus trading assets, 267n19; in mergers, 89; and need for banking regulation, 81; and securitization, 58; in tax code, 139–40 income: corporate, definition of, 140; per capita, impact of financial crisis of 2007–2009 on, 237n42 Independent Commission on Banking (ICB), 90, 218n8, 321n28, 325n53 indexed debt, 276n6 India, banking crisis in, 258n22 Industriekreditbank, 258n27, 259n29, 266n9, 299n45 inflation: of 1970s, 53; money creation in, 157–58, 276n6, 294n14, 295n16, 296n26, 297n37, 322n34; in Germany, 294n14 information contagion, 269n24 innovation, role of risk taking in, 216 innovations, financial: of 1980s and 1990s, 57–59; and interconnectedness, 66–69; risk management through, 68–74; and safety of banking system, 70–74.

The Age of Turbulence: Adventures in a New World (Hardback) - Common by Alan Greenspan

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air freight, airline deregulation, Albert Einstein, asset-backed security, bank run, Berlin Wall, Bretton Woods, business process, call centre, capital controls, central bank independence, collateralized debt obligation, collective bargaining, conceptual framework, Corn Laws, corporate governance, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, cuban missile crisis, currency peg, Deng Xiaoping, Dissolution of the Soviet Union, Doha Development Round, double entry bookkeeping, equity premium, everywhere but in the productivity statistics, Fall of the Berlin Wall, fiat currency, financial innovation, financial intermediation, full employment, Gini coefficient, Hernando de Soto, income inequality, income per capita, invisible hand, Joseph Schumpeter, labor-force participation, labour market flexibility, laissez-faire capitalism, land reform, Long Term Capital Management, Mahatma Gandhi, manufacturing employment, market bubble, means of production, Mikhail Gorbachev, moral hazard, mortgage debt, new economy, North Sea oil, oil shock, open economy, pets.com, Potemkin village, price mechanism, price stability, Productivity paradox, profit maximization, purchasing power parity, random walk, reserve currency, risk tolerance, Ronald Reagan, shareholder value, short selling, Silicon Valley, special economic zone, the payments system, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, total factor productivity, trade liberalization, trade route, transaction costs, transcontinental railway, urban renewal, working-age population, Y2K

But when the deposits are insured in some way, a run is less likely. Studying the damage caused by Depression-era bank runs had led me to conclude that, on balance, deposit insurance is a positive.* Nonetheless, the presence of a government financial safety net undoubtedly fosters "moral hazard," the term used in the insurance business to describe why customers take actions they would not so readily consider were they not insured against the adverse consequences of their behavior. Regulations on lending and deposit taking hence must be carefully designed to minimize the moral hazard they inevitably create. Democracy requires trade-offs. I was delighted that being a regulator was not the burden I had feared. Of the hundreds of Board votes on regulation during my tenure, I found myself in the minority just once. (I argued that a consumer law requiring disclosure of an interest rate relied on a method of calculation that was faulty—scarcely a major point of philosophical debate.)

All these initiatives came to a head at the same time, prompting Bob to say in retrospect, "We must have set some kind of record for disturbing the slumber of finance ministers and central bankers all over the world." There was always the chance that a rescue this large would set a bad precedent: how many more times would investors pour money into willing but shaky economies, figuring that if they got into big enough trouble, the IMF would bail them out? This was a version of what the insurance industry calls the "moral hazard" of protecting individuals from risk. The bigger the safety net, the theory goes, the greater the recklessness with which people, businesses, or governments will tend to behave. Yet the consequences of allowing South Korea to default would have been worse, possibly far worse. A default by a nation of Korea's size would almost certainly have destabilized global markets. Major banks in Japan and elsewhere would likely have failed, sending additional tremors through the system.

(Herbert Greenspan), 21 Regan, Don, 9 2 - 9 3 , 98 regulation, 370-76, 388, 4 3 0 - 3 1 , 491-92 AG's rules of t h u m b for, 374-75 counterparty surveillance, 3 7 0 - 7 1 , 373, 489 economic future and, 467, 468, 4 8 9 - 9 3 , 502 government, 15, 256, 264-65, 273, 279, 280, 291,292,372-76,489,502 Reinhart, Vincent, 377 religion, 17, 140n, 252, 271, 272 Reminiscences of a Stock Operator (Lefevre), 28 Republicans, Republican Party, 58, 75, 86, 96, 1 1 1 13, 122, 148, 158, 208, 211, 221, 222, 2 3 3 ^ 8 , 504 budget surplus and, 184, 185 F O M C a n d , 152 Republic Steel, 45, 47 Reserve Bank of Australia, 292, 293 Resolution Trust Corporation (RTC), 116-17, 290 retirement, 174, 406, 409-22, 482, 504 age at, 413n defined-benefit pensions and, 419-22 extension of labor force participation vs., 411 ratio of dependent elderly to workers and, 409-10 see also Medicare; pensions, pension funds; Social Security Reuss, Henry, 70 Revolutionary War, 480 Reynolds, 49, 50 risk taking, risk, 140, 256, 272-73, 276, 356, 365, 434, 488-89, 492, 498, 503 aversion to, 17, 273, 360, 365 moral hazard and, 189 profits and, 3 6 8 - 7 0 Rivers, Larry, 27 Rivlin, Alice, 145, 162, 173, 176 Rockefeller, David, 8 1 , 84 Rockefeller, John D., 444, 449 Rockefeller, Nelson, 80 Rogers, John H., 361 n Roosa, Robert, 84 Roosevelt, Franklin Delano, 3 1 , 159, 246, 337, 431, 439 New Deal and, 2 1 , 30, 279, 504 Roosevelt, Theodore, 336 Roth, William, 92 Rove, Karl, 223 Royal Dutch Shell, 336, 339n, 438 Rubin, Robert, 7, 145, 146, 157-62, 170, 210, 220, 405 Asian contagion and, 188, 189-90, 195 budget surplus and, 185 Russian crisis and, 193 stock market and, 174-75, 179 Rubinomics, 161, 236 rule of law, 15, 16, 255-56, 297, 365, 396, 502 economic future and, 467, 468, 469-70, 503 in Europe, 277, 287 in Russia, 190, 327, 331-32, 500 Smith and, 261 in United States, 52, 278 Rumsfeld, Donald, 62, 64, 209, 210 Russia, 135-36, 139-40, 259, 275, 293, 310, 3 2 2 23, 334n debt default of, 190-96, 250, 328, 331 future of, 500 market capitalism in, 123-24, 139-40, 323-27, 503 oil and gas in, 190, 3 2 4 - 3 1 , 440, 443 oligarchs in, 139, 140, 190, 324, 326 property rights in, 139-40, 190, 327, 331-32, 389, 500 shock therapy in, 138—40 technology in, 3 3 1 , 388 see also Soviet Union Safire, William, 57 Sala-i-Martin, Xavier, 259n-60n Samuelson, Robert, 230 S&P 500, 207, 224, 426n, 465 Sao Tome and Principe, 258-59 Sarbanes, Paul, 154-55, 2 2 1 , 478 Sarbanes-Oxley Act (2002), 374, 430-31 Sarkozy, Nicolas, 288, 500 Saudi Arabia, 79-80, 334n, 351, 438n oil of, 79, 438n Saudi Aramco, 79, 439, 440, 442 savings, 12, 138, 185, 270, 348-52, 362, 369, 3 8 4 88, 4 7 8 , 4 9 9 cross-border, 348, 352, 484 in developing vs. industrialized countries, 13, 386, 484 domestic, current account balance and, 348—49, 350 excess of, 13-14 future standards of living and, 413 investment vs., 348-49, 385, 386-87 savings accounts, 114, 115 savings and loans (S&Ls), 6, 114-17, 290, 357n SBC Communications, 229 Scargill, Arthur, 283 Scholes, Myron, 193 527 More ebooks visit: http://www.ccebook.cn ccebook-orginal english ebooks This file was collected by ccebook.cn form the internet, the author keeps the copyright.


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Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism by Ha-Joon Chang

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affirmative action, Albert Einstein, Big bang: deregulation of the City of London, bilateral investment treaty, borderless world, Bretton Woods, British Empire, Brownian motion, call centre, capital controls, central bank independence, colonial rule, Corn Laws, corporate governance, David Ricardo: comparative advantage, Deng Xiaoping, Doha Development Round, en.wikipedia.org, falling living standards, Fellow of the Royal Society, financial deregulation, fixed income, Francis Fukuyama: the end of history, income inequality, income per capita, industrial robot, Isaac Newton, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, labour mobility, land reform, low skilled workers, market bubble, market fundamentalism, Martin Wolf, means of production, moral hazard, offshore financial centre, oil shock, price stability, principal–agent problem, Ronald Reagan, South Sea Bubble, structural adjustment programs, The Wealth of Nations by Adam Smith, trade liberalization, transfer pricing, urban sprawl, World Values Survey

As the name makes it clear, it is only measuring the ‘perception’ revealed in surveys of technical experts and businessmen, who have their own limited knowledge and biases. The problem with such a subjective measure is well illustrated by the fact that the perceptions of corruption in the Asian countries affected by the 1997 financial crisis suddenly rose significantly after the crisis, despite having almost constantly fallen in the preceding decade (see H-J. Chang [2000], ‘The Hazard of Moral Hazard – Untangling the Asian Crisis’, World Development, vol. 28, no. 4). Also, what is perceived as corruption depends on the country, thus affecting the expert perception too. For example, in a lot of countries, US-style spoils disbursement of government jobs will be considered corrupt, but it is not considered so in the US. Applying, say, the Finnish definition will make the US more corrupt than is captured by the index (the US was ranked the 17th).

If they are punished for poor management, the fact that their company survives thanks to government bail-out is neither here nor there for them. Therefore, even though soft budget constraints are more likely for SOEs due to their ownership status, the key cause of the problem is the incentives for the SOE managers, rather than soft budget constraints. If that is the case, privatization is unlikely to change the performances of the enterprises involved. For further discussion, see H-J. Chang (2000), ‘The Hazard of Moral Hazard – Untangling the Asian Crisis’, World Development, vol. 28, no. 4. 3 T. Georgakopolous, K. Prodromidis, & J. Loizides (1987), ‘Public Enterprises in Greece’, Annals of Public and Cooperative Economics, vol. 58, no. 4. 4 The Wall Street Journal, May 24 1985, as quoted in J. Roddick (1988), The Dance of the Millions: Latin America and the Debt Crisis (Latin America Bureau, London), p109. 5 Temasek Holdings owns majority shares in the following enterprises: 100% of Singapore Power (electricity and gas) and of PSA International (ports), 67% of Neptune Orient Lines (shipping), 60% of Chartered Semiconductor Manufacturing (semiconductor), 56% of SingTel (telecommunications), 55% of SMRT (rail, bus and taxi services), 55% of Singapore Technologies Engineering (engineering) and 51% of SembCorp Industries (engineering).


pages: 262 words: 83,548

The End of Growth by Jeff Rubin

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Ayatollah Khomeini, Bakken shale, banking crisis, Berlin Wall, British Empire, call centre, carbon footprint, collateralized debt obligation, collective bargaining, Credit Default Swap, credit default swaps / collateralized debt obligations, decarbonisation, deglobalization, energy security, eurozone crisis, Exxon Valdez, Fall of the Berlin Wall, fiat currency, flex fuel, full employment, ghettoisation, global supply chain, Hans Island, happiness index / gross national happiness, housing crisis, hydraulic fracturing, illegal immigration, income per capita, Jane Jacobs, labour mobility, McMansion, Monroe Doctrine, moral hazard, new economy, Occupy movement, oil shale / tar sands, oil shock, peak oil, Ponzi scheme, quantitative easing, race to the bottom, reserve currency, Ronald Reagan, South China Sea, sovereign wealth fund, The Chicago School, The Death and Life of Great American Cities, Thomas Malthus, Thorstein Veblen, too big to fail, uranium enrichment, urban planning, urban sprawl, women in the workforce, working poor, Yom Kippur War

They don’t get paid by investors who base decisions on their ratings, but by the issuers of the securities that are being rated. Big agencies such as Standard & Poor’s, Moody’s and Fitch have a vested interest in keeping the folks who pay the bills happy. In economics we use the term moral hazard to describe a situation in which the interests of two parties entering into an agreement aren’t aligned. The way debt rating agencies are compensated, they have an incentive to hand out generous ratings while at the same time they’re insulated from the negative consequences of being wrong. That’s a dangerous combination. Investment bankers will tell you that steering clear of moral hazard requires keeping your head up and your eyes open. When the housing market crashed, CIBC and other financial institutions were caught skating across the ice with their heads down. They paid dearly for it on the bottom line.


pages: 353 words: 110,919

The Road to Character by David Brooks

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Cass Sunstein, David Brooks, desegregation, Donald Trump, follow your passion, Mahatma Gandhi, meta analysis, meta-analysis, moral hazard, New Journalism, Ralph Waldo Emerson, rent control, Snapchat, Steve Jobs, Triangle Shirtwaist Factory, union organizing, Upton Sinclair, upwardly mobile

Her own desires and her own ego became less central and the cause itself became more central to the structure of her life. The niceties of her class fell away. She became impatient with the way genteel progressives went about serving the poor. She became impatient with their prissiness, their desire to stay pure and above the fray. Perkins hardened. She threw herself into the rough and tumble of politics. She was willing to take morally hazardous action if it would prevent another catastrophe like the one that befell the women at the Triangle factory. She was willing to compromise and work with corrupt officials if it would produce results. She pinioned herself to this cause for the rest of her life. Summoned Today, commencement speakers tell graduates to follow their passion, to trust their feelings, to reflect and find their purpose in life.

He reminded readers that we are never as virtuous as we think we are, and that our motives are never as pure as in our own accounting. Even while acknowledging our own weaknesses and corruptions, Niebuhr continued, it is necessary to take aggressive action to fight evil and injustice. Along the way it is important to acknowledge that our motives are not pure and we will end up being corrupted by whatever power we manage to attain and use. “We take and must continue to take morally hazardous actions to preserve our civilization,” Niebuhr wrote in the middle of the Cold War. “We must exercise our power. But we ought neither to believe that a nation is capable of perfect disinterestedness in its exercise nor become complacent about particular degrees of interest and passion which corrupt the justice by which the exercise of power is legitimized.”36 Behaving in this way, he continued, requires the innocence of a dove and the shrewdness of a serpent.


pages: 209 words: 89,619

The Precariat: The New Dangerous Class by Guy Standing

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8-hour work day, banking crisis, barriers to entry, Bertrand Russell: In Praise of Idleness, call centre, Cass Sunstein, centre right, collective bargaining, corporate governance, crony capitalism, deindustrialization, deskilling, fear of failure, full employment, hiring and firing, Honoré de Balzac, housing crisis, illegal immigration, immigration reform, income inequality, labour market flexibility, labour mobility, land reform, libertarian paternalism, low skilled workers, lump of labour, marginal employment, Mark Zuckerberg, means of production, mini-job, moral hazard, Naomi Klein, nudge unit, pensions crisis, placebo effect, post-industrial society, precariat, presumed consent, quantitative easing, remote working, rent-seeking, Richard Thaler, rising living standards, Ronald Coase, Ronald Reagan, science of happiness, shareholder value, Silicon Valley, The Market for Lemons, The Nature of the Firm, The Spirit Level, Tobin tax, transaction costs, universal basic income, unpaid internship, winner-take-all economy, working poor, working-age population, young professional

The employed majority may think this is fair, though they would not accept it if applied to themselves (or their children). Unfortunately, in a utilitarian situation, the unfairness will be ignored or dismissed. A majority will be happy. The state is delegating job placement activities to commercial providers, paying them by the number of unemployed placed in jobs or by the measured reduction in claimant numbers. This commercialisation of what was once a public service sets up several moral hazards. It depersonalises to the point of making it neither a service nor public but merely a commodifying transaction. The intermediary is a firm, and in a market economy a firm exists with one overriding mandate, to make profits. Imagine the scenario. An agent wants a man put in a job quickly, to increase the agent’s own income. There is a job paying a minimum wage at the other end of town; it is unpleasant but it is a job.

A desirable step towards a basic income is integration of the tax and benefit systems. In 2010, a development moving the United Kingdom towards a basic income came from what many would have thought an unlikely direction. The Coalition government’s plans for radical reform of the tax-benefit system recognised that the system of fifty-one benefits that the previous government had built up, many with different eligibility criteria, was befuddling and rife with moral hazards linked to poverty and unemployment traps. In amalgamating state benefits into two – a Universal Work Credit and a Universal Life Credit – it would have been possible to advance tax-benefit integration and facilitate a more orderly tapering of withdrawal of benefits as earned income rose. Integration could create the circumstances for a basic income to emerge. Sadly, the work and pensions minister, a Catholic, was persuaded to force benefit recipients to labour, ushering in workfare and allowing commercial agents to have control.


pages: 347 words: 99,317

Bad Samaritans: The Guilty Secrets of Rich Nations and the Threat to Global Prosperity by Ha-Joon Chang

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affirmative action, Albert Einstein, banking crisis, Big bang: deregulation of the City of London, bilateral investment treaty, borderless world, Bretton Woods, British Empire, Brownian motion, call centre, capital controls, central bank independence, colonial rule, Corn Laws, corporate governance, David Ricardo: comparative advantage, Deng Xiaoping, Doha Development Round, en.wikipedia.org, falling living standards, Fellow of the Royal Society, financial deregulation, fixed income, Francis Fukuyama: the end of history, income inequality, income per capita, industrial robot, Isaac Newton, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, labour mobility, land reform, low skilled workers, market bubble, market fundamentalism, Martin Wolf, means of production, moral hazard, offshore financial centre, oil shock, price stability, principal–agent problem, Ronald Reagan, South Sea Bubble, structural adjustment programs, The Wealth of Nations by Adam Smith, trade liberalization, transfer pricing, urban sprawl, World Values Survey

As the name makes it clear, it is only measuring the ‘perception’ revealed in surveys of technical experts and businessmen, who have their own limited knowledge and biases. The problem with such a subjective measure is well illustrated by the fact that the perceptions of corruption in the Asian countries affected by the 1997 financial crisis suddenly rose significantly after the crisis, despite having almost constantly fallen in the preceding decade (see H-J. Chang [2000], ‘The Hazard of Moral Hazard – Untangling the Asian Crisis’, World Development, vol. 28, no. 4). Also, what is perceived as corruption depends on the country, thus affecting the expert perception too. For example, in a lot of countries, US-style spoils disbursement of government jobs will be considered corrupt, but it is not considered so in the US. Applying, say, the Finnish definition will make the US more corrupt than is captured by the index (the US was ranked the 17th).

If they are punished for poor management, the fact that their company survives thanks to government bail-out is neither here nor there for them. Therefore, even though soft budget constraints are more likely for SOEs due to their ownership status, the key cause of the problem is the incentives for the SOE managers, rather than soft budget constraints. If that is the case, privatization is unlikely to change the performances of the enterprises involved. For further discussion, see H-J. Chang (2000), ‘The Hazard of Moral Hazard – Untangling the Asian Crisis’, World Development, vol. 28, no. 4. 3 T. Georgakopolous, K. Prodromidis, & J. Loizides (1987),‘Public Enterprises in Greece’, Annals of Public and Cooperative Economics, vol. 58, no. 4. 4 The Wall Street Journal, May 24 1985, as quoted in J. Roddick (1988), The Dance of the Millions: Latin America and the Debt Crisis (Latin America Bureau, London), p109. 5 Temasek Holdings owns majority shares in the following enterprises: 100% of Singapore Power (electricity and gas) and of PSA International (ports), 67% of Neptune Orient Lines (shipping), 60% of Chartered Semiconductor Manufacturing (semiconductor), 56% of SingTel (telecommunications), 55% of SMRT (rail, bus and taxi services), 55% of Singapore Technologies Engineering (engineering) and 51% of SembCorp Industries (engineering).

The End of Accounting and the Path Forward for Investors and Managers (Wiley Finance) by Feng Gu

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Affordable Care Act / Obamacare, barriers to entry, business process, Claude Shannon: information theory, Clayton Christensen, conceptual framework, corporate governance, Daniel Kahneman / Amos Tversky, discounted cash flows, diversified portfolio, double entry bookkeeping, Exxon Valdez, financial innovation, fixed income, hydraulic fracturing, index fund, inventory management, Joseph Schumpeter, knowledge economy, moral hazard, new economy, obamacare, quantitative easing, quantitative trading / quantitative finance, QWERTY keyboard, race to the bottom, risk/return, Robert Shiller, Robert Shiller, shareholder value, Steve Jobs, The Great Moderation, value at risk

The industry is regulated in the United States at the state level, including regulation of insurance prices. Competition, particularly in the consumer segment of the business is fierce, evidenced by the substantial amount spent by insurance companies on advertising (Geico’s gecko, Progressive’s Flo). There are several large but not dominant firms in the industry (State Farm, Geico, Allstate). Insurers face two major issues: in the economists’ parlance, adverse selection and moral hazard. The former refers to the tendency of individuals or companies with high risk (e.g., seriously ill people) to obtain more coverage than low-risk persons, and the latter refers to the tendency of the insured to engage in riskier behavior (neglect house maintenance) relative to uninsured, and, at the extreme, to fake claims. Both of these hazards are mitigated by smart customer management, as you’ll see shortly.

Other strategic assets are brands (Allstate’s Esurance), intellectual property (patents on new products, like Snapshot, Progressive’s plugged-in-the-car device to track individual driving behavior and offer personalized premiums), and dedicated, productive agents. Back to customers. What are the “right” customers assuring sustained competitive advantage? These are persons with low adverse selection and moral hazard (defined earlier), namely, low-risk (safe drivers), and careful (property maintaining) customers. Successful strategy (referred to as book management) is aimed at targeting such customers (Hartford, for example, teamed Strategic Resources & Consequences Report: Case No. 2 149 up with AARP, the dominant retirees association, to market insurance to AARP members—older people are, on average, conscientious, low-mileage drivers, carefully maintaining their cars), and holding on to them as long as possible with attractive rates and good customer relations (claims management).

When the Money Runs Out: The End of Western Affluence by Stephen D. King

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Albert Einstein, Asian financial crisis, asset-backed security, banking crisis, Basel III, Berlin Wall, Bernie Madoff, British Empire, capital controls, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, congestion charging, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, cross-subsidies, debt deflation, Deng Xiaoping, Diane Coyle, endowment effect, eurozone crisis, Fall of the Berlin Wall, financial innovation, financial repression, floating exchange rates, full employment, George Akerlof, German hyperinflation, Hyman Minsky, income inequality, income per capita, inflation targeting, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, joint-stock company, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, London Interbank Offered Rate, loss aversion, market clearing, moral hazard, mortgage debt, new economy, New Urbanism, Nick Leeson, Northern Rock, Occupy movement, oil shale / tar sands, oil shock, price mechanism, price stability, quantitative easing, railway mania, rent-seeking, reserve currency, rising living standards, South Sea Bubble, sovereign wealth fund, technology bubble, The Market for Lemons, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, Tobin tax, too big to fail, trade route, trickle-down economics, Washington Consensus, women in the workforce, working-age population

More was to follow: the 1990 recession was surprisingly mild, the 1994 collapse in the US Treasury market, when bond yields rose dramatically, was shrugged off with remarkable ease, the 1997 Asian crisis hardly registered beyond the – by now tiny – US manufacturing sector, the 2000 technology-­related stock-­market crash was followed by only the gentlest of recessions, while the recovery that followed seemingly confirmed that American policy-­makers, in their collective wisdom, knew how to avoid a Japanese-­style stagnation. Greenspan couldn’t see the wolves of depression and stagnation hiding in the woods. Investors began to believe the world was safe. Unwittingly, however, policy-­makers had created a huge moral hazard problem. If nothing could really go wrong – if recessions were now milder, inflation permanently lower and depression now only an artefact of economic history – it was worth taking more risk. The West’s economic illusion was most obviously reflected in persistent increases in asset prices relative to the size of economies. Asset prices reflect a set of beliefs about the future. Asset price gains suggest the future may be brightening whereas asset price falls suggest the opposite.

L. 41 Knickerbocker Trust Company 131 Korea 14, 193, 195, 202–4, 205 Krugman, Paul 112–15, 117, 118–19 labour market 115–16, 252 productivity 53 Landes, David 26 Latin American debt crisis 216 Layard, Richard 114, 117 Lehman Brothers 30, 255 Leveson inquiry 148 Libor 126 life expectancy 47 liquidity 84, 90 liquidity trap 72 Liquidity Coverage Ratio (LCR) 83 Little Dorrit (Dickens) 138–9 living standards 11, 27, 158, 169, 180–1 belief in ever rising 13, 34 China 27 Indonesia 197 Japan 23 Korea 195 late 19th century 185, 186 Malaysia 198 post-Second World War 139 US 11, 163 loan-to-value ratios, mortgage 51–2 Long Depression 189–90 loss aversion 40–1 lotteries 164–5 Macroeconomic Imbalance Procedure (MIP) 233 macroeconomic policies 32, 60, 121, 181, 253 Japan 21 macroprudential rules 256 Madoff, Bernie 35 Mahathir Mohamad 198–201, 205 Malaysia 193, 198–201, 205 Malthus, Thomas 37–9 Manchester United 165–6 Marr, Wilhelm 189 Marx, Karl 57, 179–80 Mary Poppins 131–2 May Report 98 Megawati Sukarnoputri 197 Mellon, Andrew 106, 108 Mexico 158 Mieno, Yasushi 21 miners 103–4 Mississippi 163 mistrust creditors and debtors 141 cross-border 176 endemic 147–9 governments 140, 217–18 of money 219–21 and political extremism 227 monetarism 59 monetary policy 58, 68–74, 77–9, 87–9, 97, 111–12 a new monetary framework 245–50 see also Gold Standard; interest rates; quantitative easing (QE) Monetary Policy Committee 90–1 monetary unions 236–7 see also eurozone moral hazard 62 mortgage-backed securities 30, 65, 136–7 mortgages 51–2, 63–5 Napoleon Bonaparte 156 Napoleon III 182 National Bank of North America 131 national incomes 32, 49–50, 141–2, 247 Germany 33 Japan 32 UK 33, 110–11, 112 US 33, 70, 109, 115, 117–18 284 4099.indd 284 29/03/13 2:23 PM Index National Lottery 164–5 nationalism 228 the Netherlands 48 New Deal 108–9 ‘new economy’ of the 1990s 29–30 New Order (Indonesia) 197 New Zealand 187 Nicholson, Viv 50 Nigeria 19 Northern Rock 30, 51–2, 129, 255 Norway 158 Occupy movement 162, 170–1 Office for Budget Responsibility 33 Oliver Twist (Dickens) 43 Osborne, George 231 Overend, Gurney and Co. 131 painkillers 70–1, 89 ‘The Panic of 1873’ 186 Paul, Ron 93 Peasants’ Revolt 213 Pension Protection Fund (PPF) 172 pensioners’ voting patterns 88 pensions 47, 51, 75, 171–3, 174 per capita incomes 27, 49, 159–60, 163 Argentina and Germany 14 China 251 France 101, 105 Germany 101, 105 India 27, 251 Indonesia 197 Japan 21 Korea 202 Malaysia 198 UK 1, 44, 101, 105 US 14, 101, 105 Perón, Eva 16 Perón, Juan 16–17 Pew Center report 173 Pickett, Kate 159 Pigou, Arthur 59 policies and central bankers 65 fiscal 58, 66–7, 69–70, 77–8, 246–7 macroeconomic 21, 32, 60, 121, 181, 253 monetary 58, 68–74, 77–9, 87–9, 97, 111–12 new monetary framework 245–50 political extremism 226–9 politics and central bankers 78, 89–90, 91–5 and economics 24–6, 34, 102, 191–2, 217 and the eurozone 224–5, 237 and expectations 152–3 and income inequality 160–1 and lack of trust 147–8, 149 and monetary regimes 119–20 voters 50, 78, 88, 222, 242–4 poll tax 211 populations, ageing 78, 88, 250 age-related expenditure 48 generational divide 171–4, 241, 243–5 Germany 136 Japan 23, 25 Portugal 50, 146, 158, 191 precious metal standards 183–4 see also Gold Standard prices asset 73 commodity 77, 109, 116–17 rising 157 see also deflation; inflation property sector see housing markets protectionism 214–15 capital controls 16, 199–200, 201, 234 tariffs 16 Protestant work ethic 26, 28 public sector see governments public spending 49–50, 66, 142, 147–8, 203 government spending 58, 109, 119 social spending 45–7 quantitative easing (QE) 72–82, 84–6, 91, 97, 176–7 ratings agencies 234–5 rationing 114–15, 142–3 recessions 2 recovery from the Asian crisis 195–6, 204–5, 206, 208–9 UK in the 1930s 101–2 redistribution by stealth 90 Reform Acts 222, 242–3 regulation 125, 256 dangers of further 214, 251 dollar transactions 177 reduction 168 the regulatory trap 83–4 Statute of Labourers 213 renminbi (currency) 177 Réveillon, Jean-Baptiste 155–6 Ricardo, David 183–4 Richard II 211–12 ringgit (currency) 198 285 4099.indd 285 29/03/13 2:23 PM When the Money Runs Out risk and banks 255–6 creditors and debtors imbalance 234 and financial services 168 and rapid economic change 170 risk aversion 216 Roosevelt, Franklin Delano 107–9, 117–18, 119, 219 Royal Bank of Scotland 30 Royal Navy 99 Russia 117, 135 Rwanda 19 Samuel, Herbert 104 Saudi Arabia 117, 135 savers and banks 136 confidence 65 and illusions 137 and income inequality 162–3 and interest rates 90, 91, 97 and the subprime boom 133–4 schisms between debtors and creditors 174–7, 191 generational 170–4 income inequality 158–70 Schwartz, Anna 59, 106, 188 second-hand car market 123–4 Sierra Leone 163 silver standard 183 SIVs (structured investment vehicles) 129–30 Skidelsky, R. and E. 37 Smith, Adam 39–40, 207 melancholy state 42, 124–5, 159–60 Snowden’s budget 99–102, 105 soccer 165 social contract, between generations 244–5 social insurance 44–8 social security systems 12 social spending 45–7 Soros, George 200 South Korea 14, 193, 195, 202–4, 205 South Sea Bubble 29 space exploration 9–10, 35 Spain deficit 54, 134 and the eurozone 191, 235–6 exports 82 fiscal position 85 government borrowing 144 interest rates 146 political disenfranchisement 95 property bubble 140 suicide of Amaia Egana 153 spending government 58, 109, 119 public sector 49–50, 66, 142, 147–8, 203 social 45–7 stagnation 37–43, 50, 52–3, 158, 219 and political extremism 227–8 Standard & Poor’s 80 ‘stately home’ effect 221–3 Statute of Labourers 211, 213 sterling 98–106, 110 Stern Review 38–9 stimulus 3–4 and jobs 116 monetary and fiscal 30, 57–8, 181 Paul Krugman 112–15, 118–19 policy 32, 69–70, 82 political debate 205 prior to the financial crisis 67 stock markets 20–1, 30, 193 stock-market crashes 18, 61–2, 66, 99, 186 Straw, Jack 212 structured investment vehicles (SIVs) 129–30 subprime boom 130, 133–4 crisis 190 Suharto 196–7, 205 surpluses 66, 135–7, 204, 232–4 Sweden 158, 204 Switzerland 158, 184 Taiwan 14 Takeshita, Noburo 24 Tanzania 19 tariffs 16 tax avoidance 49, 211, 214 taxation ancien régime and the French Revolution 154–5 death duties 139 medieval poll tax 211 taxpayers 145, 170, 174, 215, 254 technological progress 2–3, 10–11 dotcom bubble 169 and financial industry wages 167 Industrial Revolution 38 Thailand 193, 195 Thaler, R.


pages: 829 words: 229,566

This Changes Everything: Capitalism vs. The Climate by Naomi Klein

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1960s counterculture, battle of ideas, Berlin Wall, big-box store, bilateral investment treaty, British Empire, business climate, Capital in the Twenty-First Century by Thomas Piketty, carbon footprint, clean water, Climategate, cognitive dissonance, colonial rule, Community Supported Agriculture, complexity theory, crony capitalism, decarbonisation, deindustrialization, dematerialisation, Donald Trump, Downton Abbey, energy security, energy transition, equal pay for equal work, Exxon Valdez, failed state, Fall of the Berlin Wall, feminist movement, financial deregulation, food miles, Food sovereignty, global supply chain, hydraulic fracturing, ice-free Arctic, immigration reform, income per capita, Internet Archive, invention of the steam engine, invisible hand, Isaac Newton, James Watt: steam engine, market fundamentalism, moral hazard, Naomi Klein, new economy, Nixon shock, Occupy movement, offshore financial centre, oil shale / tar sands, open borders, patent troll, planetary scale, post-oil, profit motive, quantitative easing, race to the bottom, Ralph Waldo Emerson, Rana Plaza, Ronald Reagan, smart grid, special economic zone, Stephen Hawking, Stewart Brand, structural adjustment programs, Ted Kaczynski, the scientific method, The Wealth of Nations by Adam Smith, trade route, transatlantic slave trade, transatlantic slave trade, trickle-down economics, Upton Sinclair, uranium enrichment, urban planning, urban sprawl, wages for housework, walkable city, Washington Consensus, Whole Earth Catalog, WikiLeaks

During the Cold War, U.S. physicists imagined weakening the nation’s enemies by stealthily manipulating rainfall patterns, whether by causing droughts or by generating targeted storms that would turn a critical supply route into a flooded mess, as was attempted during the Vietnam War.10 So it’s little wonder that mainstream climate scientists have, until quite recently, shied away from even discussing geoengineering. In addition to the Dr. Strangelove baggage, there was a widespread fear of creating a climate moral hazard. Just as bankers take greater risks when they know governments will bail them out, the fear was that the mere suggestion of an emergency techno-fix—however dubious and distant—would feed the dangerous but prevalent belief that we can keep ramping up our emissions for another couple of decades. More out of despair than conviction, the geoengineering taboo has been gradually eroding over the past decade.

., 282 fuel prices, 112 fuel quality standards, 71 Fukushima nuclear disaster, 136, 268 G20 summits, 115 gardening, 93 gas companies, see extractive industries Gasland, 217, 304 Gass, Heather, 38 Gates, Bill, 135, 235, 236–37, 252, 254, 263, 264, 268–69, 276–77, 280, 281, 289 Gates Foundation, 236 Gauger, Ralf, 100 Gearon, Jihan, 398–99 Gemmill, Faith, 375–76 General Electric, 226 General Motors, 67, 196, 210, 221, 282 Geneva, 6 gentrification, 156 Geoclique, 263, 264, 268–69 geoengineering, 57–58, 154, 236, 255, 256–90, 447 as bridging tool, 257, 281 complexity of biosphere ignored by, 267–68, 290, 422 dangers of, 266–67, 279–80 ethics of, 277 extractive industries and, 281–84 moral hazard and, 261 negative public view of, 290 Royal Society conference on, 256–61, 263–67, 280–81, 284–85, 451 as shock doctrine, 276–78 see also Pinatubo Option; Solar Radiation Management “Geoengineering: The Horrifying Idea Whose Time Has Come” (forum), 263 geologists, economic, 46 Geophysical Research Letters, 329 George, Russ, 268 Georgia Institute of Technology, 432 Georgia Strait, 374 geothermal energy, 127 Geraghty, Jim, 52 German National Center for Aerospace, Energy and Transport Research (DLR), 138 Germany, 75, 132, 133, 162, 218, 225 energy privatization reversal in, 96–98, 127–28 feed-in tariffs in, 131, 133 growth of dirty coal use in, 136–39, 144, 224 nuclear energy phased out in, 97, 136–38 renewable energy in, 97–98, 130–31, 136–39, 224, 237, 398, 451 travel habits and wealth in, 113 Gerze, Turkey, 349 Gillette, Wyo., 343, 344, 395, 396 Gilman, Nils, 189 Gindin, Sam, 122–23 Gingrich, Newt, 35 glacier melt, 14, 15, 175 global feed-in tariff, 413–14 Global Frackdown, 304 globalization, 22, 64 corporate, 19 dawning of, 18–19 of markets, 39, 85, 171, 412 successes of, 19 Global North, 49, 314 see also developed world; postindustrialized nations Global Risks report, World Economic Forum, 112 Global South, 53, 77, 181, 309, 314, 412 Blockadia movements in, 412 environmentalism in, 202 see also developing world global warming, see climate change Globe and Mail, 325, 333 God’s Last Offer (Ayres), 280 God Species, The (Lynas), 279 gold, mining of, 296 Goldenberg, Suzanne, 312 Golden, KC, 304, 320 Goldman Sachs, 51, 208n, 352 goods, lasting vs. disposable, 85, 90 Gore, Al, 41, 67, 85, 150, 155, 211, 212, 218, 230, 233, 241, 242, 244, 385 government intervention, 42, 43, 178, 201–3 necessity for, 54–55 government regulation: corruption in, 333–34 laxity of, 330–31, 333 governments, collusion between extractive industries and, 297–99, 303, 306–7, 308, 360, 361–66, 378–80 Grandin, Greg, 455 Grantham, Jeremy, 233 Grantham, Mayo, Van Otterloo & Co., 233 Grantham Foundation for the Protection of the Environment, 233n Great Barrier Reef, 147–48, 301 Great Depression, 89, 115, 454 Great Transition, 89, 115 Greece, 466 austerity programs in, 9, 108, 131–32, 154 economic problems of, 297 government repression of anti-mining movement in, 297–98, 303 oil and gas exploration in, 22, 181–82 Skouries forest mining project in, 293–94, 296–98, 303, 314, 342, 347, 445 WTO challenges brought against, 65 Green for All, 92 Green Alliance, U.K., 90 green consumerism, 211–13 “green deserts,” 180 green energy entrepreneurs, free market and, 69–70 Green Energy and Green Economy Act, 66–69 green energy programs, trade law challenges to, 64–65, 68–69 green fascism, 54 Greenhouse Development Rights framework, 417–18 greenhouse effect, 74, 213 greenhouse gas emissions, 6, 64–65, 90, 198, 219, 259 computer models of, 270 cost of, 112 countries’ responsibility for internal, 79 cumulative effect of, 21, 40, 56, 175, 409–10, 416 decreased work hours as offset to, 94 deregulation and, 210 distorted global picture of, 79, 411–12 fracking and, 129, 143–44, 214, 217, 304 free trade and, 80–83 global gas boom and, 143–44 globalized agriculture and, 77–78 increase in, 20, 452 low wages and high, 81–82 reduction of, see emission reduction from shipping, 76, 79 standards for, 25 WTO regulations and, 71 see also carbon emissions Greenland: extraction industry in, 385 melting ice sheet in, 12, 148, 385 green NGOs, geoengineering and, 264, 280 Green Party (New Brunswick), 374 Greenpeace, 84, 156, 197, 199, 201, 205, 233n, 264, 356 anti-drilling protests of, 300 EDF spying on, 362 Greenpeace U.K., 376 green technology, 85, 87, 89–90 for developing world, 76, 85 investment in, 89, 156, 400–407, 451 green towns, 406–7 Greenwich, University of, 101 Gross Domestic Product (GDP), 92 Grunwald, Michael, 124 Guarani, 221 Guardian, 149, 312, 346, 363–64, 383 Guay, Justin, 352 Gulf Restoration Network, 425 Gupta, Sanjay, 430 Guujaaw, 368–69, 383 Haida Gwaii, 369 Haida Nation, land claims of, 368–69 Haimen, China, 350 Hair, Jay, 84, 191 Haiti, 457 Haiyan, Typhoon, 107, 175, 406 Halkidiki, Greece, 294, 342, 445 Halliburton, 330 Halliburton Loophole, 328 Hällström, Niclas, 413–14 Halstead Property, 51 Hamburg, Germany, 96–97 Hamilton, Clive, 89, 175, 264 Hansen, James, 22, 41, 73, 140 Hansen, Wiebke, 97 Harper administration (Canada), 302–3, 362 environmental protections weakened by, 381–82 “war on science” of, 326–28 Harter, John, 313 Harvard Medical School, 105 Harvard University, 81, 354–55 Hauper, Debbi, 373 Have You Ever Seen a Moose?

., 317 Minnesota, 27 Minnesota, University of, Institute on the Environment at, 58 miscarriages, environmental toxins linked to, 424–25, 429, 439 Mississippi, 431 Mississippi River: drought of 2012 in, 2–3 flooding of 2011 in, 3 Mississippi River Delta, ecological damage in, 425–26 Mitchell, Stacy, 209 Mobil, 192 Mohave Generating Station, 398 Mohit, Nastaran, 103–5 Molina, Patricia, 182 Monbiot, George, 363–64 Monsanto, 9, 80, 135, 196 monsoons, 268, 269, 270, 273–74, 287 Montana, 53n, 318, 370, 381 coal mining in, 320, 342–43, 346, 370, 388–93, 395, 397, 445 Environmental Quality Department of, 397 State Land Board of, 389 Monterey Shale, 347 Montreal, Canada, 313 Montreal, Maine & Atlantic railroad, 333 Montreal Protocol on ozone depletion, 220 moose, disappearance of, 26–27 Morales, Evo, 180–81 moral hazard, geoengineering and, 261 moral imperative: in abolition movement, 462–63 in climate movement, 336, 386–87, 464 divestment movement and, 354–55 in social movements, 462, 463–64 Morano, Marc, 32, 34, 45 Morton, Oliver, 259 Mosaddegh, Mohammad, 454 Moses, Marlene, 64, 449 Mossville, La., 429–30 Mother Earth, see Earth Mother/Mother Earth concept Mount Elgon National Park, 222 Movement Generation, 448 Movement for the Survival of the Ogoni People (MOSOP), 306 Mueller, Tadzio, 138 Muir, John, 183–84, 211 Mukherji, Joydeep, 368–69 multinational corporations: cheapest labor force and, 81–82 export-led development and, 82, 412 Mumbai, 13 Munich, Germany, 97 Murdoch, Rupert, 35 Myhrvold, Nathan, 262, 264, 269, 277, 280, 281 Nagasaki, atomic bombing of, 277–78 Narain, Sunita, 96, 414 NASA, 14, 152 earth-from-space photographs by, 286 Goddard Institute for Space Studies at, 22, 73 NatCen Social Research, 117 Nation, 420 National Academy of Sciences, U.S., 152, 282 National Association of Manufacturers, 227 National Audubon Society, 84 National Center for Atmospheric Research, 272 National Energy Board, Canada, 362 National Environment Appellate Authority, India, 350 National Guard, 103 National Oceanic and Atmospheric Administration (NOAA), U.S., 102, 426, 432–33, 434, 436 national security, 49 National Toxics Campaign, 206 National Union of Rail, Maritime and Transport Workers, 253 National Wildlife Federation, 84, 185, 191, 226, 390, 393 Native American cosmologies, 184 natural gas, 67, 102, 219 Big Green’s advocacy of, 199–201, 235n, 236 as bridge fuel, 128–30, 211, 213–14, 252, 257, 287 climate benefits of, 144n conventional, 215 flaring of, 305–6 fracking and, see fracking renewables displaced by, 44n, 128–30, 214–16, 252 for vehicles, 237 Willett’s support for, 235–36 natural gas industry: Sierra Club and, 197 strategic miscalculations by, 316–17 Natural Resource Partners, 349 Natural Resources Defense Council, 84, 115, 198, 205, 213, 226, 325, 357 Move America Beyond Oil campaign, 231 Nature, 37, 259 nature: delayed response of, 175 fertility cycle of, 438–39, 446–48 legal rights of, 443–45 steam power and freedom from, 172–74 Nature Climate Change, 290 Nature Conservancy, 191–95, 196, 206, 208n, 210, 212n, 226, 233n, 355 Business Council of, 196 fracking supported by, 215 oil and gas drilling by, 192–95, 196, 206, 215, 451 Paraná offset and, 221, 222 Nauru, 64, 161–69, 175, 187, 221n, 311 Australian offshore refugee detention center on, 166–67 independence of, 162 phosphate of lime in, 162–63 Navajo, 398–99 Navarro Llanos, Angélica, 5–7, 40, 409 Navigable Waters Protection Act, gutting of, 381–82 Nebraska, 403 Nelson, Gaylord, 153 neoliberalism, 39, 43, 72–73, 80, 131, 132, 154, 158, 466 Netherlands, 99 anti-fracking movement in, 348 divestment movement in, 354 neuropathy, 436, 438 “New Abolitionism, The” (Hayes), 455 New America Foundation, 263 New Atlantis (Bacon), 266 New Brunswick: anti-fracking campaign in, 299, 303, 370, 373–74, 381 Indigenous rights conflict in, 371–74 oil train explosion in, 333 New Deal, 10, 453, 454 New Democratic Party (Canadian), 36 New England, 441 New Era Colorado, 98 New Era Windows Cooperative, 123n Newfoundland, anti-fracking movement in, 348 New Green Revolution, 135 New Jersey, Superstorm Sandy in, 53 New New Deal (Grunwald), 124 New Orleans, La., 4, 9, 53, 105, 407 New South Wales, anti-coal movement in, 300–301, 376 New York, N.Y., 13, 63, 103–6, 157 Bloomberg as mayor of, 235 disaster infrastructure in, 51 New Yorkers Against Fracking, 214 New York State: anti-fracking ordinances in, 361, 365 fracking in, 316–17 fracking moratorium in, 348 renewable power plan for, 102 Superstorm Sandy in, 53, 405 New York Times, 333, 411 New York Times Magazine, 286 New Zealand, 163, 182, 290 Nexen, 246 Nez Perce, 319, 370 Nicaragua, 348n Niger, 270 Niger Delta, 197, 219 government repression of anti-oil movements in, 306–7, 308, 370 oil extraction in, 305–9, 358 Nigeria, 219, 305 carbon emissions of, 305 colonial heritage of, 370 political unrest in, 308–9, 358 Nile River, volcanic eruptions and, 273 Nilsson, David, 220–21 9/11, 6, 63 Nixon, Richard, 125 Nixon, Rob, 276 Nompraseurt, Torm, 321 nonbinding agreements, at Copenhagen, 12, 13–14, 150 nongovernmental organizations (NGOs), 362 geoengineering and, 264, 280 Norgaard, Kari, 462 Norse Energy Corporation USA, 365 North Africa, 274 North America, 182 emissions from, 40 program cuts in, 110 wealth in, 114 World War II rationing in, 115–16 North American Free Trade Agreement (NAFTA), 19, 71, 76, 78, 83–85, 358–59 North Dakota, Bakken formation in, 71 Northern Cheyenne, 322–23, 346, 370, 386, 389–93, 399 traditional values of, 391–92 unemployment among, 391 Northern Cheyenne Reservation, 322, 389, 390, 397, 408 fire on, 396 solar heaters for, 393–96 Northern Gateway pipeline, 312, 362, 381 campaign against, 302, 337–42, 344–45, 365–66, 367, 380 cost of, 400 Joint Review Panel for, 337–42, 363, 365 North Texas, University of, 312 North Vancouver, Canada, 323 Norway, 99, 130, 179, 198 Nova Scotia, 371 npower, 149 nuclear holocaust, 15 nuclear power, 57, 58, 97, 118, 131, 199, 202, 205 Germany’s phasing out of, 97, 136–38 “next generation” technologies for, 137n, 236 in the wake of Fukushima, 136 Obama, Barack, 12, 227, 392, 412 “all of the above” energy policy of, 22, 302, 304–5 environmental agenda of, 45, 118, 120–21, 141–42 and fossil fuel industry, 141 health care law of, 105, 125, 151, 227 and Keystone XL, 140–41, 403 responses to financial crisis by, 120–26 support for biofuels by, 32 Occupy Sandy, 103–5, 406 Occupy Wall Street, 103, 153, 206, 464 Oceana, 330–31 oceans, 175 acidification of, 165, 259, 434 dead zones in, 439 iron “fertilization” in, 257, 258, 268, 279 see also marine life O’Connor, John, 327 Office of Price Administration, 115 offshore drilling, 22, 80, 144 deepwater, 2, 142, 300, 310, 324 lifting of limits on, 145 see also Arctic drilling; BP, Deepwater Horizon disaster of Ogallala Aquifer, 346 Ogoni, Ogoniland, 306, 309, 370 oil, 102, 128, 215 Oil Change International, 115 oil industry, 197 political and economic power of, 316 public ownership of, 130 and drop in conventional production, 147 see also extractive industries Oil Sands Leadership Initiative (OSLI), 246 Ojo, Godwin Uyi, 306, 309 Okanagan, land claims of, 368 O’Neill, Gerard, 288 One Million Climate Jobs, 127 Ontario, 56, 382 feed-in tariffs in, 67, 133 local content provision challenged in, 68–70, 71, 99, 126 renewable energy sector in, 66–69 Oomittuk, Steve, 375 Operation Climate Change, 307–8 opposition movements, 9–10 see also Blockadia; climate movement Oregon, 319, 320, 349 Oreskes, Naomi, 42 Organisation for Economic Co-operation and Development (OECD), 114–15 Orwell, George, 96 Osuoka, Isaac, 307–8 Otter Creek, Mont., 322–23, 389, 397 Our Hamburg—Our Grid coalition, 96–97 oysters, 431–32, 434 ozone depletion, 16 Pacala, Stephen, 113 Pacific Northwest: ecological values of, 319–20 proposed coal export terminals in, 320, 322, 346, 349, 370, 374 Pacific Ocean, acidification of, 434 Paine, Tom, 314 Palin, Sarah, 1 palm oil plantations, 222 Papanikolaou, Marilyn, 361 Papua New Guinea, 200, 220 Paradise Built in Hell (Solnit), 62–63 Paraná, Brazil, 221, 222 Parenti, Christian, 49, 186 Parfitt, Ben, 129 Paris, public transit in, 109 Parkin, Scott, 296 Parr, Michael, 227 particulate pollution, 176 Passamaquoddy First Nation, 371–72 Patel, Raj, 136 Patles, Suzanne, 381 Paulson, Henry, 49 Peabody Energy, 391 Pearl River Delta, 82 Pelosi, Nancy, 35 Pendleton, Oreg., 319 Peninsula Hospital Center, 104 Penn State Earth System Science Center, 55 Pennsylvania: fracking in, 357n Homeland Security Office of, 362 water pollution in, 328–29 Pensacola, Fla., 431 permafrost, 176 Peru, 78, 220–21 pest outbreaks, 14 Petrobras, 130 PetroChina, 130 Pew Center on Global Climate Change, 226 Pew Research Center for People & the Press, 35 Philippines, 107, 109 Phillips, Wendell, 463 phosphate of lime, 163–64, 166 photovoltaic manufacturing, 66 Pickens, T.


pages: 828 words: 232,188

Political Order and Political Decay: From the Industrial Revolution to the Globalization of Democracy by Francis Fukuyama

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Affordable Care Act / Obamacare, Andrei Shleifer, Asian financial crisis, Atahualpa, banking crisis, barriers to entry, Berlin Wall, blood diamonds, British Empire, centre right, clean water, collapse of Lehman Brothers, colonial rule, conceptual framework, crony capitalism, deindustrialization, Deng Xiaoping, double entry bookkeeping, Edward Snowden, Erik Brynjolfsson, European colonialism, facts on the ground, failed state, Fall of the Berlin Wall, first-past-the-post, Francis Fukuyama: the end of history, Francisco Pizarro, Frederick Winslow Taylor, full employment, Gini coefficient, Hernando de Soto, Home mortgage interest deduction, income inequality, invention of the printing press, iterative process, knowledge worker, land reform, land tenure, life extension, low skilled workers, manufacturing employment, means of production, Menlo Park, Mohammed Bouazizi, Monroe Doctrine, moral hazard, new economy, open economy, out of africa, Peace of Westphalia, Port of Oakland, post-industrial society, Post-materialism, post-materialism, price discrimination, quantitative easing, RAND corporation, rent-seeking, road to serfdom, Ronald Reagan, Scientific racism, Scramble for Africa, Second Machine Age, Silicon Valley, special economic zone, stem cell, the scientific method, The Wealth of Nations by Adam Smith, Thomas L Friedman, Thomas Malthus, too big to fail, trade route, transaction costs, Tyler Cowen: Great Stagnation, women in the workforce, World Values Survey

Many American conservatives denounced President Obama’s 2010 Affordable Care Act as “socialism,” but the fact was that at the time, the United States was alone among rich democratic countries in the world in not having some form of mandated universal health insurance. Liberal theorists from John Locke to Friedrich Hayek have always been skeptical of government-mandated redistribution, since it threatens to reward the lazy and incompetent at the expense of the virtuous and hardworking. And indeed, all redistributive programs incur what economists call “moral hazard”: by rewarding people based on their level of income rather than their individual effort, the government discourages work. This was of course the case in former Communist countries such as the Soviet Union, where “the government pretended to pay us and we pretended to work.” On the other hand, it is morally difficult to justify a minimalist state that provides no safety net whatsoever for its less fortunate citizens.

This would work only in a society where the playing field was always perfectly level, and in which accidents of birth or simple luck had no role in determining the life chances, wealth, and opportunities faced by individuals. But such a society has never existed in the past, and does not exist today. The real question facing most governments, then, is less whether to redistribute than at what level to do so, and how to redistribute in ways that minimize moral hazard. The problem of inherited advantages usually increases over time. Elites tend to get more entrenched because they can use their wealth, power, and social status to get access to the government, and to use the power of the state to protect themselves and their children. This process will continue until nonelites succeed in mobilizing politically to reverse it or otherwise protect themselves.

Hart Mexican-American War Mexican Revolution Mexico; PRI in; War of Independence in Middle Ages middle classes; in Argentina; in Brazil; in China; clientelism and; conversion of working class into; corruption and; defining; and future of democracy; size of, relative to rest of society Middle East; compared with nineteenth-century Europe Migdal, Joel Miguel, Edward military competition military conquest, geography and military slavery Mill, James Mill, John Stuart Mobutu Sese Seko modernization; classic path to; national identity and; without development; see also industrialization Modi, Narendra Moi, Daniel arap Moltke, Helmuth von Mondell, Frank Mongols Monroe, James Montesquieu, Charles Secondat, Baron de Montezuma Monti, Mario Moore, Barrington moral hazard Morel, E. D. Morelos, José María Morrill Act Morris, Edmund Morris, Ian Morsi, Mohamed Mosca, Gaetano Mozambique Mubarak, Hosni Muir, John Munn v. Illinois Museveni, Yoweri Muslims, see Islam Mussolini, Benito Napoleon I, Emperor Napoleon III, Emperor Napoleonic Wars National Association for the Advancement of Colored People (NAACP) national character nationalism, see nation building and national identity Nationalism, Islam, and Marxism (Sukarno) National Security Agency nation building and national identity; and adjusting identities to fit political realities; cultural assimilation and; and defining of political borders; four routes to; historical amnesia and; in Indonesia; in Kenya; in Latin America; linguistic unification and; modernization and; and moving or eliminating populations; in Nigeria; state building and; in Tanzania; in United States; violence and NATO Nazis neopatrimonialism Netherlands New Deal New York, N.Y.


pages: 503 words: 131,064

Liars and Outliers: How Security Holds Society Together by Bruce Schneier

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airport security, barriers to entry, Berlin Wall, Bernie Madoff, Bernie Sanders, Brian Krebs, Broken windows theory, carried interest, Cass Sunstein, Chelsea Manning, corporate governance, crack epidemic, credit crunch, crowdsourcing, cuban missile crisis, Daniel Kahneman / Amos Tversky, David Graeber, desegregation, don't be evil, Double Irish / Dutch Sandwich, Douglas Hofstadter, experimental economics, Fall of the Berlin Wall, financial deregulation, George Akerlof, hydraulic fracturing, impulse control, income inequality, invention of agriculture, invention of gunpowder, iterative process, Jean Tirole, John Nash: game theory, joint-stock company, Julian Assange, meta analysis, meta-analysis, microcredit, moral hazard, mutually assured destruction, Nate Silver, Network effects, Nick Leeson, offshore financial centre, patent troll, phenotype, pre–internet, principal–agent problem, prisoner's dilemma, profit maximization, profit motive, race to the bottom, Ralph Waldo Emerson, RAND corporation, rent-seeking, RFID, Richard Thaler, risk tolerance, Ronald Coase, security theater, shareholder value, slashdot, statistical model, Steven Pinker, Stuxnet, technological singularity, The Market for Lemons, The Nature of the Firm, The Spirit Level, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, too big to fail, traffic fines, transaction costs, ultimatum game, UNCLOS, union organizing, Vernor Vinge, WikiLeaks, World Values Survey, Y2K

We see this with various product schemes. Whether it's Citibank selling credit cards and consumer loans and anti-theft protection plans to go with those credit cards; or Apple selling computer hardware and software; or Verizon bundling telephone, cable, and Internet; product bundles and subscription services hide prices and make it harder for customers to make buying decisions. There's also a moral hazard here. The less Citibank spends on antifraud measures, the more protection plans it can sell; the higher its credit card interest rates, the more attractive its consumer loans are. Large corporations can also use one revenue stream to subsidize another. So a big-box retail store can temporarily lower its prices so far that it's losing money, in order to drive out competition. Or an airline can do the same with airfares in certain markets to kill an upstart competitor.

But as long as the maximum possible penalty to the corporation is bankruptcy, there will be illegal activities that are perfectly rational to undertake as long as the probability of penalty is small enough.20 Any company that is too big to fail—that the government will bail out rather than let fail—is the beneficiary of a free insurance policy underwritten by taxpayers. So while a normal-sized company would evaluate both the costs and benefits of defecting, a too-big-to-fail company knows that someone else will pick up the costs. This is a moral hazard that radically changes the risk trade-off, and limits the effectiveness of institutional pressure. Of course, I'm not saying that all corporations will make these calculations and do whatever illegal activity is under consideration. There are still both moral and reputational pressures in place that keep both individuals and corporations from defecting. But the increasing power and scale of corporations is making this kind of failure more likely.


pages: 543 words: 147,357

Them And Us: Politics, Greed And Inequality - Why We Need A Fair Society by Will Hutton

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Andrei Shleifer, asset-backed security, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Bretton Woods, capital controls, carbon footprint, Carmen Reinhart, Cass Sunstein, centre right, choice architecture, cloud computing, collective bargaining, conceptual framework, Corn Laws, corporate governance, credit crunch, Credit Default Swap, debt deflation, decarbonisation, Deng Xiaoping, discovery of DNA, discovery of the americas, discrete time, diversification, double helix, Edward Glaeser, financial deregulation, financial innovation, financial intermediation, first-past-the-post, floating exchange rates, Francis Fukuyama: the end of history, Frank Levy and Richard Murnane: The New Division of Labor, full employment, George Akerlof, Gini coefficient, global supply chain, Growth in a Time of Debt, Hyman Minsky, I think there is a world market for maybe five computers, income inequality, inflation targeting, interest rate swap, invisible hand, Isaac Newton, James Dyson, James Watt: steam engine, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, knowledge worker, labour market flexibility, Long Term Capital Management, Louis Pasteur, low-wage service sector, mandelbrot fractal, margin call, market fundamentalism, Martin Wolf, means of production, Mikhail Gorbachev, millennium bug, moral hazard, mortgage debt, new economy, Northern Rock, offshore financial centre, open economy, Plutocrats, plutocrats, price discrimination, private sector deleveraging, purchasing power parity, quantitative easing, race to the bottom, railway mania, random walk, rent-seeking, reserve currency, Richard Thaler, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, Rory Sutherland, shareholder value, short selling, Silicon Valley, Skype, South Sea Bubble, Steve Jobs, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, the scientific method, The Wealth of Nations by Adam Smith, too big to fail, unpaid internship, value at risk, Washington Consensus, working poor, éminence grise

The IMF has shrunk from going so far, instead proposing a bank levy to compensate for future bail-outs and a financial activities tax to try to restrain the growth of overmighty finance. The latter could raise revenues equal to 1 per cent of GDP. The IMF is trying to do the right thing, but agreement among the G20 has been painfully slow. Britain should proceed ahead of any international agreement because the UK needs additional tax revenue; because it needs to send a signal about its insistence that bankers pay for the moral hazard they create; because it is concerned about the size of the financial sector in relation to the UK economy as a whole; and because it wants to stimulate others into following suit. Here again the coalition government has dared to do what the outgoing Labour government did not, although its proposed levy is very small. The IMF has also floated the idea of removing the tax deductibility of interest on bank debt.

Coval, Jakub Jurek and Erik Stafford (2008) ‘The Economics of Structured Finance’, Harvard Business School Working Paper No. 09-060. 18 Andrew Haldane (2010) ‘The $100 Billion Question’, presentation to the Institute of Regulation & Risk, Hong Kong. 19 Steven Dunaway (2009) ‘Global Imbalances and the Financial Crisis’, Special Report No. 44, Council of Foreign Relations, Center for Geoeconomic Studies. 20 Michael Keeley (1990), ‘Deposit Insurance, Risk and Market Power in Banking’, American Economic Review 80: 1183–1200. See also Thomas Hellman, Kevin Murdock and Joseph Stiglitz (2000) ‘Liberalization, Moral Hazard in Banking and Prudential Regulation: Are Capital Requirements Enough?’, American Economic Review 90 (1): 147–65; and Gabriel Jimenez, Jose Lopez and Jesus Saurina (2007) ‘How Does Competition Impact Bank Risk-Taking?’, Federal Reserve Bank of San Francisco Working Paper No. 2007–23. 21 Walter Bagehot (1873; 1908) Lombard Street: A Description of the Money Market, at http://socserv.mcmaster.ca/econ/ugcm/3ll3/bagehot/lombard.html. 22 Hyun Song Shin (2009) ‘Reflections on Northern Rock: The Bank Run that Heralded the Global Financial Crisis’, Journal of Economic Perspectives 23 (1): 101–19. 23 William Cohan (2009) House of Cards: A Tale of Hubris and Wretched Excess on Wall Street, Allen Lane, p. 32. 24 Dani Rodrik (2007) ‘The False Promise of Financial Liberalization’, Project Syndicate, at http://www.project-syndicate.org/commentary/rodrik14. 25 See the response of the National Association of Insurance Commissioners: NAIC Response to Treas-DO-2007-0018, 28 November 2007, at http://www.naic.org/documents/topics_federal_regulator_treasury_response_0711.pdf. 26 Daniel K.


pages: 320 words: 87,853

The Black Box Society: The Secret Algorithms That Control Money and Information by Frank Pasquale

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Affordable Care Act / Obamacare, algorithmic trading, Amazon Mechanical Turk, asset-backed security, Atul Gawande, bank run, barriers to entry, Berlin Wall, Bernie Madoff, Black Swan, bonus culture, Brian Krebs, call centre, Capital in the Twenty-First Century by Thomas Piketty, Chelsea Manning, cloud computing, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, crowdsourcing, cryptocurrency, Debian, don't be evil, Edward Snowden, en.wikipedia.org, Fall of the Berlin Wall, Filter Bubble, financial innovation, Flash crash, full employment, Goldman Sachs: Vampire Squid, Google Earth, Hernando de Soto, High speed trading, hiring and firing, housing crisis, informal economy, information retrieval, interest rate swap, Internet of things, invisible hand, Jaron Lanier, Jeff Bezos, job automation, Julian Assange, Kevin Kelly, knowledge worker, Kodak vs Instagram, kremlinology, late fees, London Interbank Offered Rate, London Whale, Mark Zuckerberg, mobile money, moral hazard, new economy, Nicholas Carr, offshore financial centre, PageRank, pattern recognition, precariat, profit maximization, profit motive, quantitative easing, race to the bottom, recommendation engine, regulatory arbitrage, risk-adjusted returns, search engine result page, shareholder value, Silicon Valley, Snapchat, Spread Networks laid a new fibre optics cable between New York and Chicago, statistical arbitrage, statistical model, Steven Levy, the scientific method, too big to fail, transaction costs, two-sided market, universal basic income, Upton Sinclair, value at risk, WikiLeaks

As markets crashed in September, the U.S. Treasury “saved” AIG, infusing the firm with capital— over $100 billion— and paying its obligations to firms like Goldman at 100 cents on the dollar, despite the fact that there was no government guarantee of the value of CDSes. Amazingly, the government did not use its leverage at the 116 THE BLACK BOX SOCIETY moment of crisis to penalize AIG counterparties. Deeply concerned about “moral hazard” in other situations, officials at Treasury and the Fed made the bettors whole rather than teaching them a lesson about overleveraging. For a real “learning moment,” for example, Treasury could have imposed numerous conditions designed to assure the banks acted in the best interest of the citizens whose tax dollars rescued them. Instead, it allowed some of the worst actors in the crisis not only to keep their gains but to make even more afterwards pursuing similarly risky strategies.

Legal changes pushing workers and companies into “defi ned contribution” rather than “defined benefit” or public pension plans have fueled the growth of the fi nancial sector. James W. Russell, Social Insecurity: 401(k)s and the Retirement Crisis (Boston: Beacon Press, 2014); Robin Blackburn, Banking on Death (London: Verso, 2004). 278 NOTES TO PAGES 133–135 146. Peter Boone and Simon Johnson describe how a “doomsday cycle” of privatized gains and socialized losses continues to this day. Peter Boone and Simon Johnson, “Will the Politics of Global Moral Hazard Sink Us Again?,” in The Future of Finance. See also Paul De Grauwe and Yuemei Ji, “Strong Government, Weak Banks,” CEPS Policy Brief No. 305, November 25, 2013, http:// www.ceps.eu /ceps/dld /8646/pdf (and note how those “earning” the most at banks want them weak; a strong institution would do more to limit their pay). 147. Associated Press, “10-Year Treasury Yield Rises from Near Record Low,” May 18, 2012.


pages: 448 words: 142,946

Sacred Economics: Money, Gift, and Society in the Age of Transition by Charles Eisenstein

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Albert Einstein, back-to-the-land, bank run, Bernie Madoff, big-box store, Bretton Woods, capital controls, clean water, collateralized debt obligation, credit crunch, David Ricardo: comparative advantage, debt deflation, deindustrialization, delayed gratification, disintermediation, diversification, fiat currency, financial independence, financial intermediation, floating exchange rates, Fractional reserve banking, full employment, global supply chain, happiness index / gross national happiness, hydraulic fracturing, informal economy, invisible hand, Jane Jacobs, land tenure, Lao Tzu, liquidity trap, lump of labour, McMansion, means of production, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, new economy, oil shale / tar sands, Own Your Own Home, peak oil, phenotype, Ponzi scheme, profit motive, quantitative easing, race to the bottom, Scramble for Africa, special drawing rights, spinning jenny, technoutopianism, the built environment, Thomas Malthus, too big to fail

By ensuring the solvency of risk-taking financial institutions and the liquidity of their financial offerings, the government has effectively increased the risk-free rewards of owning money and accelerated the concentration of wealth. No longer is the Fed Funds rate or T-bill rate the benchmark of risk-free interest. The concept of moral hazard that has come up in the context of “too big to fail” financial institutions isn’t just a moral issue. When risky, high-interest bets are not actually risky, then those with the money to make such bets will increase their wealth far faster than (and at the expense of) everyone else. Moral hazard is a shortcut to extreme concentration of wealth. 7. The conservative argument that putting money in the hands of the wealthy will spur increased investment, more jobs, and prosperity for all holds only if the rate of return on capital so invested exceeds the prevailing interest rate on risk-free financial investment.


pages: 497 words: 123,718

A Game as Old as Empire: The Secret World of Economic Hit Men and the Web of Global Corruption by Steven Hiatt; John Perkins

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airline deregulation, Andrei Shleifer, Asian financial crisis, Berlin Wall, big-box store, Bretton Woods, British Empire, capital controls, centre right, clean water, colonial rule, corporate governance, corporate personhood, deglobalization, deindustrialization, Doha Development Round, energy security, European colonialism, financial deregulation, financial independence, full employment, global village, high net worth, land reform, large denomination, Long Term Capital Management, Mexican peso crisis / tequila crisis, Mikhail Gorbachev, moral hazard, Naomi Klein, new economy, North Sea oil, offshore financial centre, oil shock, Ponzi scheme, race to the bottom, reserve currency, Ronald Reagan, Scramble for Africa, statistical model, structural adjustment programs, too big to fail, trade liberalization, transatlantic slave trade, transfer pricing, union organizing, Washington Consensus, working-age population, Yom Kippur War

On the horizon, we should anticipate a similar “non-free market” response if Ford or General Motors are threatened with bankruptcy. • As for sovereign country borrowers, in 1953, under the impact of the Cold War and the desire to see Western Europe recover, the U.S. helped to arrange a generous debt restructuring for West Germany, including a 50-percent debt write-off and a thirty-year repayment schedule for the balance owed. In short, when it comes to debt relief—“sanctity of contract,” “moral hazard,” and other neoliberal canons notwithstanding—if the borrowers in question are large enough and have enough political influence, they have usually qualified for exceptional treatment. This offshore labor force sends home a stream of remittance income now estimated at up to $250 billion each year. But much of this money is wasted in high transfer costs and misspending. Clearly, depending heavily on labor exports—as the Philippines, El Salvador, Mexico, Haiti, and Ecuador are now doing—is not the best policy; it is a poor substitute for generating jobs and incomes at home.

These demands were especially hard to justify in light of the fact that HIPCs on the final list were hardly prime prospects for First World banks, contractors, or equipment suppliers. Fully half had populations smaller than New Jersey’s, with per capita incomes averaging less than $1,100, and average life expectancies of just forty-nine years. Offering this group of countries debt relief was not likely to set a dangerous “moral hazard” precedent. Nevertheless, under the original 1996 HIPC I scheme, all these countries expected to spend three years implementing such reforms under the BWIs’ watchful eye before they reached a “decision point.” Then a debt-relief package would be assembled and a modest amount of relief would finally be approved. Countries were then supposed to continue their good behavior for another three years before reaching the “completion point,” at which point they’d finally see a serious reduction in debt service.


pages: 393 words: 115,263

Planet Ponzi by Mitch Feierstein

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Affordable Care Act / Obamacare, Albert Einstein, Asian financial crisis, asset-backed security, bank run, banking crisis, barriers to entry, Bernie Madoff, centre right, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, disintermediation, diversification, Donald Trump, energy security, eurozone crisis, financial innovation, financial intermediation, Flash crash, floating exchange rates, frictionless, frictionless market, high net worth, High speed trading, illegal immigration, income inequality, interest rate swap, invention of agriculture, Long Term Capital Management, moral hazard, mortgage debt, Northern Rock, obamacare, offshore financial centre, oil shock, pensions crisis, Plutocrats, plutocrats, Ponzi scheme, price anchoring, price stability, purchasing power parity, quantitative easing, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, too big to fail, trickle-down economics, value at risk, yield curve

Any real banker would fight for the exact opposite. It is (to use a fine Britishism) gobsmacking that the Bank of England is willing to further debauch the pound by quantitative easing, at a time when long-term bond yields, the target for such nontraditional measures, are already at record lows. ‘Moral hazard’ is a term much used in economics. It means that if you reward people for ineptitude or remove penalties from failure, you will encourage precisely the behaviors that you least want to see. Central bankers and regulators should be the fierce guardians of moral hazard: the angels with the flaming swords. They’ve become the exact reverse. One congressional inquiry, for example, saw the following interchange between Representative Alan Grayson and Elizabeth Coleman, the Fed’s Inspector General. (You can see the whole thing on YouTube, if you care to.)


pages: 504 words: 143,303

Why We Can't Afford the Rich by Andrew Sayer

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accounting loophole / creative accounting, Albert Einstein, asset-backed security, banking crisis, banks create money, Bretton Woods, British Empire, call centre, capital controls, carbon footprint, collective bargaining, corporate social responsibility, credit crunch, Credit Default Swap, crony capitalism, David Graeber, David Ricardo: comparative advantage, debt deflation, decarbonisation, declining real wages, deglobalization, deindustrialization, delayed gratification, demand response, don't be evil, Double Irish / Dutch Sandwich, en.wikipedia.org, Etonian, financial innovation, financial intermediation, Fractional reserve banking, full employment, Goldman Sachs: Vampire Squid, high net worth, income inequality, investor state dispute settlement, Isaac Newton, James Dyson, job automation, Julian Assange, labour market flexibility, laissez-faire capitalism, low skilled workers, Mark Zuckerberg, market fundamentalism, Martin Wolf, means of production, moral hazard, mortgage debt, neoliberal agenda, new economy, New Urbanism, Northern Rock, Occupy movement, offshore financial centre, oil shale / tar sands, patent troll, payday loans, Plutocrats, plutocrats, predatory finance, price stability, pushing on a string, quantitative easing, race to the bottom, rent-seeking, Ronald Reagan, shareholder value, short selling, sovereign wealth fund, Steve Jobs, The Nature of the Firm, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, transfer pricing, trickle-down economics, universal basic income, unpaid internship, upwardly mobile, Washington Consensus, Winter of Discontent, working poor, Yom Kippur War

Now it has become clear that major banks are too big to fail, they have still less incentive to act prudently, as they are seen as a safe risk by other companies – indeed they can raise credit more easily than banks that are small enough to fail! When the rewards of acting in an anti-social way are greater than the penalties for doing so, this is called ‘moral hazard’. According to Mervyn King, the ‘massive support extended to the banking sector around the world … has created possibly the biggest moral hazard in history’.136 Champions of free enterprise, who had campaigned against state regulation and poured scorn on the public sector and welfare state, were happy to pocket state subsidies on a hitherto unseen scale. Contrite they were not. Losing none of their brazenness, they then lobbied fiercely and mostly successfully against state regulation of the sector, so that they could continue to live the adolescent dream of unconditionally supported autonomy.


pages: 475 words: 155,554

The Default Line: The Inside Story of People, Banks and Entire Nations on the Edge by Faisal Islam

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Asian financial crisis, asset-backed security, balance sheet recession, bank run, banking crisis, Basel III, Ben Bernanke: helicopter money, Berlin Wall, Big bang: deregulation of the City of London, British Empire, capital controls, carbon footprint, Celtic Tiger, central bank independence, centre right, collapse of Lehman Brothers, credit crunch, Credit Default Swap, crony capitalism, dark matter, deindustrialization, Deng Xiaoping, disintermediation, energy security, Eugene Fama: efficient market hypothesis, eurozone crisis, financial deregulation, financial innovation, financial repression, floating exchange rates, forensic accounting, forward guidance, full employment, ghettoisation, global rebalancing, global reserve currency, hiring and firing, inflation targeting, Irish property bubble, Just-in-time delivery, labour market flexibility, London Whale, Long Term Capital Management, margin call, market clearing, megacity, Mikhail Gorbachev, mini-job, mittelstand, moral hazard, mortgage debt, mortgage tax deduction, mutually assured destruction, North Sea oil, Northern Rock, offshore financial centre, open economy, paradox of thrift, pension reform, price mechanism, price stability, profit motive, quantitative easing, quantitative trading / quantitative finance, race to the bottom, regulatory arbitrage, reserve currency, reshoring, rising living standards, Ronald Reagan, savings glut, shareholder value, sovereign wealth fund, The Chicago School, the payments system, too big to fail, trade route, transaction costs, two tier labour market, unorthodox policies, uranium enrichment, urban planning, value at risk, working-age population

Shriti Vadera picked up the phone to John Varley at Barclays: ‘We need you to know that everybody else is here,’ she told him. ‘If you wish to come in we will talk to you.’ Varley was holed up at his Canary Wharf office, refusing repeated requests from Vadera and Myners to come to the Treasury. Instead, Varley and his team waited for notification of the amount of capital required, and handled all meetings by conference call. Varley’s team sensed ‘menace’ from the Bank of England and its desire to avoid ‘moral hazard’. In his office a board member challenged Varley to convince him that refusing government capital was not simply about keeping his job. He conceded that a failure to raise private capital would see him in a difficult position. By March he had agreed to raise £7 billion, a figure he told friends was ‘seared onto his heart’. By the end of October, Barclays had indeed paid £300 million in fees in order to acquire £7 billion of expensive capital – principally from two private investors, connected to royal families in Abu Dhabi and Qatar.

The Irish economy made up less than 2 per cent of the Eurozone, but Ireland received 25 per cent of all loans made by central banks within the Eurozone. Emergency funds were designed to be advanced to solvent banks facing a liquidity problem under the centuries-old doctrine of ‘lender of last resort’. The precise parameters of solvency were, however, unclear under the policy of ‘constructive ambiguity’ designed to prevent moral hazard by banks. In other words, the central bankers would not identify in advance how they would rescue troubled banks, because, rightly, they feared bankers would abuse the privilege and indulge in risky funding, knowing they would be supported by their central bank. Unfortunately, the ambiguity was more destructive than constructive. In October 2010 the ECB tightened its risk control framework (its rules on emergency funding), seemingly with Ireland in mind, which brings us to the third way in which Frankfurt defined Ireland’s fate.


pages: 518 words: 147,036

The Fissured Workplace by David Weil

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accounting loophole / creative accounting, affirmative action, Affordable Care Act / Obamacare, banking crisis, barriers to entry, business process, call centre, Carmen Reinhart, Cass Sunstein, Clayton Christensen, clean water, collective bargaining, corporate governance, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, declining real wages, employer provided health coverage, Frank Levy and Richard Murnane: The New Division of Labor, George Akerlof, global supply chain, global value chain, hiring and firing, income inequality, intermodal, inventory management, Jane Jacobs, Kenneth Rogoff, law of one price, loss aversion, low skilled workers, minimum wage unemployment, moral hazard, Network effects, new economy, occupational segregation, performance metric, pre–internet, price discrimination, principal–agent problem, Rana Plaza, Richard Florida, Richard Thaler, Ronald Coase, shareholder value, Silicon Valley, statistical model, Steve Jobs, supply-chain management, The Death and Life of Great American Cities, The Nature of the Firm, transaction costs, ultimatum game, union organizing, women in the workforce, Y2K, yield management

Because many people sell cars because of problems they have with them, buyers in the market assume the worst (in part because they cannot easily see the quality of any given car). Because of this expectation, the price for used cars is pushed down, so that even the seller of a good car will be forced to receive a lower price than the true value of the vehicle warrants. 57. A well-known problem arising from this is moral hazard, where a principal ends up creating precisely the wrong incentives for agents. For example, when selling fire insurance to customers, the insurer hopes that they will be careful in regard to fire safety. But since the customers now know that damages will be covered, they become more, rather than less, careless. 58. Some literature asserts by assumption that contracting is impossible with little acknowledgment of the often heroic efforts made by businesses to map out many aspects of the relationships between business organizations.

., 195, 345n33 Milliken, Michael, 53 Mine Improvement and New Emergency Response Act (MINER Act), 317n24, 357n55, 359n62 Mine Safety and Health Act, 102–103, 238 Mine Safety and Health Administration (MSHA), 101–103, 357n55; and enforcement outlays, 215–216; and POV program, 238–240, 358n59, 358n60 Minimum wage standards, 326n19, 349n65; violations, 9, 18, 130, 132; and fast food industry, 130; and janitorial services industry, 140; and hospitality industry, 154; and apparel industry, 226 Misclassification of workers, 10, 212, 236. See also Independent contracting M corporation, origins of, 31–34 Monopsony, 296n25, 309nn4–5, 309n7, 313n33; power, 79–81; model, 87 Moore’s Law, 61 Moral hazard, 306n57 Morgan Foods, 129 Mt. Olive Pickles, 260 Munro Muffler Company, 229–230 Mutual funds, 45–46 Nail salons, 256 National Employment Law Project, 284, 293n20 National Franchise Program (Australia), 224 National Labor Relations Act (NLRA), 41, 77, 184–185, 207, 246, 316n11; definition of employee, 21; and posting of notices, 253 National Labor Relations Board, 185, 292n14; NLRB v.


pages: 422 words: 113,830

Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism by Kevin Phillips

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algorithmic trading, asset-backed security, bank run, banking crisis, Bernie Madoff, Black Swan, Bretton Woods, BRICs, British Empire, collateralized debt obligation, computer age, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency peg, diversification, Doha Development Round, energy security, financial deregulation, financial innovation, fixed income, Francis Fukuyama: the end of history, George Gilder, housing crisis, Hyman Minsky, imperial preference, income inequality, index arbitrage, index fund, interest rate derivative, interest rate swap, Joseph Schumpeter, Kenneth Rogoff, large denomination, Long Term Capital Management, market bubble, Martin Wolf, Menlo Park, mobile money, Monroe Doctrine, moral hazard, mortgage debt, new economy, oil shale / tar sands, oil shock, peak oil, Plutocrats, plutocrats, Ponzi scheme, profit maximization, Renaissance Technologies, reserve currency, risk tolerance, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, sovereign wealth fund, The Chicago School, Thomas Malthus, too big to fail, trade route

If we are headed into an era of rekindling government economic activism sufficient to resurrect an old term like “mercantilism” and embellish it with four, five, or six subcategories, then some greater precision may be in order. Take the three-decade pattern of bailouts extended by Federal Reserve chairman Ben Bernanke in his August-September minuet of full-fledged rate cuts, discount window enlargements, and emergency liquidity injections. The old pomposity “moral hazard” has lost relevance as “assets hazard” has become the feared bogeyman. Sometime back in the naive eighties, Milton Friedman rightly called banking “a major sector of the economy in which no enterprise ever fails, no one ever goes broke. . . . The banking industry has been a highly protected, sheltered industry. That’s because the banks have been the constituency of the Federal Reserve.”30 Political foes have called the bailout procession “Wall Street socialism,” and financial markets watcher James Grant, seeking cooler precision, has coined the term “socialization of credit risk.”

The ratings agencies—Standard & Poor’s, Moody’s, and Fitch—were collaborative (some said complicit) in bestowing high-safety classifications that are in hindsight almost mind-boggling. Drexel University finance professor Joseph Mason told the Associated Press of bonds backed by delinquent credit card accounts in which up to 40 percent of the accounts in the security were rated AAA.10 However, institutional customers at home and abroad were clamoring for the high yields attached, and perceptions of “moral hazard” were minimal, especially in New York. The nation’s seventeenth-biggest bank based somewhere out in the hinterland might not rate a bailout, but Manhattan megabankers were confident of their own place on Helicopter Ben’s chopper route.b Indeed, New York’s Citigroup had already benefited from a bailout arranged by the Federal Reserve back in 1991. Another attraction that asset-backed securities and structured CDOs held for the financial community was turnover—no waiting around for payment over the life of an individual loan.


pages: 261 words: 10,785

The Lights in the Tunnel by Martin Ford

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Albert Einstein, Bill Joy: nanobots, Black-Scholes formula, call centre, cloud computing, collateralized debt obligation, credit crunch, double helix, en.wikipedia.org, factory automation, full employment, income inequality, index card, industrial robot, inventory management, invisible hand, Isaac Newton, job automation, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, knowledge worker, low skilled workers, moral hazard, pattern recognition, prediction markets, Productivity paradox, Ray Kurzweil, Search for Extraterrestrial Intelligence, Silicon Valley, Stephen Hawking, strong AI, superintelligent machines, technological singularity, Thomas L Friedman, Turing test, Vernor Vinge, War on Poverty

Transitioning to the New Model Now that we have seen how the government might be able to support the consumers of the future by redirecting incentive-based income streams captured through taxation, we can begin to think about how to transition into this new model. The primary problem we face is that the current economy is still highly reliant on human labor. We need to develop a system that avoids creating a disincentive to perform necessary work. In other words, we don’t want to create inequities by requiring some people to work and not others, and we don’t want a “moral hazard” that pushes people to avoid work and seek government support instead. The answer must be some type of job sharing solution. The exact mechanics of this solution would need to vary depending of the nature of the job. For many job types, it might be possible to simply move toward a part time work schedule so that more people are employed doing the same amount of work. For jobs that do not lend Copyrighted Material – Paperback/Kindle available @ Amazon THE LIGHTS IN THE TUNNEL / 186 themselves to part time work, a rotation scheme could be used.

Trend Commandments: Trading for Exceptional Returns by Michael W. Covel

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Albert Einstein, Bernie Madoff, Black Swan, commodity trading advisor, correlation coefficient, delayed gratification, diversified portfolio, en.wikipedia.org, Eugene Fama: efficient market hypothesis, family office, full employment, Lao Tzu, Long Term Capital Management, market bubble, market microstructure, Mikhail Gorbachev, moral hazard, Nick Leeson, oil shock, Ponzi scheme, prediction markets, quantitative trading / quantitative finance, random walk, Sharpe ratio, systematic trading, the scientific method, transaction costs, tulip mania, upwardly mobile, Y2K

The Wall, writer Roger Waters, EMI, 1979. 2. Sally Hogshead, Fascinate: Your 7 Triggers to Persuasion and Captivation. New York: Harper Collins, 2010, p. 117. 3. “Mind Over Money: Can Markets Be Rational When Humans Are Not?” NOVA, April 26, 2010. 4. Ibid. 5. Ibid. 6. Ibid. 7. Ibid. 8. Ibid. 248 9. Tre n d C o m m a n d m e n t s James Montier, “Mind Matters: Forever Blowing Bubbles: Moral Hazard and Melt-up.” Societe Generale, June 2, 2009. 10. “The Monsters Are Due on Maple Street.” The Twilight Zone, March 4, 1960. 11. Barry Ritholtz, “Why politics and investing don’t mix.” Washington Post, February 6, 2011. Speculari 1. Wall Street: Money Never Sleeps, dir. Oliver Stone, perf. Michael Douglas, DVD, 20th Century Fox, 2010. 2. Wall Street, dir. Oliver Stone, perf. Michael Douglas, DVD, 20th Century Fox, 1987. 3.

Global Financial Crisis by Noah Berlatsky

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accounting loophole / creative accounting, asset-backed security, banking crisis, Bretton Woods, capital controls, Celtic Tiger, centre right, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, deindustrialization, Doha Development Round, energy security, eurozone crisis, financial innovation, Food sovereignty, George Akerlof, Gordon Gekko, housing crisis, illegal immigration, income inequality, market bubble, market fundamentalism, moral hazard, new economy, Northern Rock, purchasing power parity, quantitative easing, race to the bottom, regulatory arbitrage, reserve currency, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, South China Sea, structural adjustment programs, too big to fail, trade liberalization, transfer pricing, working poor

See Persian Gulf region Migrant workers Chinese, 110, 116, 130 Eastern Europeans, 98 Filipinos, 152, 154 International Organization for Migration, 132–134 remittances, 152, 160, 161, 198 United Kingdom (other Europeans), 113–114 xenophobia and job losses, 129–134 Military spending China, 145 Israel, 121, 124, 126 U.S. subsidies, 203, 204 Millennium Development Goals, UN, 136, 191 Mises, Ludwig von, 59, 61–62, 63 Monbiot, George, 201–206 Moral hazard, 34 Moral virtues, 30–31 Mortgage-based securities, 17, 174, 175, 176 Mortgage crisis, U.S., 16–17, 33– 34, 54–55 causes: boom thinking, 32–41 causes: greed, 27–31 causes: regulation blockage, 205–206 cost estimates, 220 See also Subprime mortgages Mortgage originators, 33 Index Mortgage rates raising, 90 subprime spikes, 34 N NAFTA, 180, 182, 183–184 Nashville, Tennessee, 77–78 National debts Australia, 89, 90 Europe, 94, 95, 100 United Kingdom, 60 United States, 60–61 Nationalization.


pages: 225 words: 61,388

Dead Aid: Why Aid Is Not Working and How There Is a Better Way for Africa by Dambisa Moyo

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affirmative action, Asian financial crisis, Bretton Woods, colonial rule, correlation does not imply causation, credit crunch, diversification, diversified portfolio, en.wikipedia.org, European colonialism, failed state, financial innovation, financial intermediation, Hernando de Soto, income inequality, invisible hand, M-Pesa, market fundamentalism, Mexican peso crisis / tequila crisis, microcredit, moral hazard, Ponzi scheme, rent-seeking, Ronald Reagan, sovereign wealth fund, The Chicago School, trade liberalization, transaction costs, trickle-down economics, Washington Consensus, Yom Kippur War

Consider again a group of borrowers in a small rural village, where the lender has virtually no information on the individual borrowers. Joint liability gets around this information asymmetry in a number of ways. When forming their groups, borrowers have an incentive at the onset to match themselves with other good borrowers, and exclude those known to be high-risk. Naturally, this self-selection mechanism helps the lender screen the borrowers and reduce the risk of default. Joint liability also addresses the moral hazard lenders typically face – that is, the risk that once a loan is made, once the borrower has secured the cash, she defaults. Under joint liability, other members of the group have a vested interest to ensure their partners do not cheat, to see the loan repaid, so that they too can access funds. Having seen the explosion and success in micro-finance (micro-finance default rates in Zambia are less than 5 per cent), traditional banks have woken up to the opportunity that hitherto they have left untapped.


pages: 236 words: 77,735

Rigged Money: Beating Wall Street at Its Own Game by Lee Munson

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affirmative action, asset allocation, backtesting, barriers to entry, Bernie Madoff, Bretton Woods, buy low sell high, California gold rush, call centre, Credit Default Swap, diversification, diversified portfolio, estate planning, fiat currency, financial innovation, fixed income, Flash crash, follow your passion, German hyperinflation, High speed trading, housing crisis, index fund, joint-stock company, moral hazard, passive investing, Ponzi scheme, price discovery process, random walk, risk tolerance, risk-adjusted returns, risk/return, too big to fail, trade route, Vanguard fund, walking around money

For intrepid investors, I offer my version of trading options. If old and stodgy is your style, sit back for Chapter 11, where I explain why dividends matter and why on some level they’re irrelevant. Most importantly, I will tell you how all these things get turned into a pitch which Wall Street cares about nothing except selling you something. To top it off, I unveil the New Scam. Thanks to deregulation and a complete disregard for moral hazard, we start a new century with banking and brokerage joined together like it was 100 years ago, with essentially the same effect: bedlam. Ladies and gentlemen, I give you the rigged game! Additional Materials For updates and more information, go to www.riggedmoney.com. Acknowledgments I’d like to thank acquisition editor Laura Walsh for her passion behind the project and Judy Howarth for putting up with my writing.


pages: 267 words: 82,580

The Dark Net by Jamie Bartlett

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3D printing, 4chan, bitcoin, blockchain, brain emulation, carbon footprint, crowdsourcing, cryptocurrency, deindustrialization, Edward Snowden, Filter Bubble, Francis Fukuyama: the end of history, global village, Google Chrome, Howard Rheingold, Internet of things, invention of writing, Johann Wolfgang von Goethe, Julian Assange, Kuwabatake Sanjuro: assassination market, life extension, litecoin, Mark Zuckerberg, Marshall McLuhan, moral hazard, Occupy movement, pre–internet, Ray Kurzweil, Satoshi Nakamoto, Skype, slashdot, technological singularity, technoutopianism, Ted Kaczynski, The Coming Technological Singularity, Turing test, Vernor Vinge, WikiLeaks, Zimmermann PGP

He recounts that during the Cold War, Soviet cyphers were too strong for GCHQ to break, so British intelligence switched to recruiting more Soviet agents. If the state considers you to be a legitimate target for security investigation but can’t track your online activity using an anonymous browser, they’ll put a bug in your bedroom instead. He predicts more agents and intrusive operations in future, ‘which is typically more morally hazardous’. For the cypherpunks, the fact that criminals use encryption is an unfortunate outcome, but a cost worth paying for the extra freedom it provides. Zimmermann has been asked repeatedly how he feels that the 9/11 hijackers might have used software he designed. It was, he says, far outweighed by the fact PGP is ‘a tool for human rights around the world . . . strong crypto does more good for a democratic society than harm.’

Blindside: How to Anticipate Forcing Events and Wild Cards in Global Politics by Francis Fukuyama

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Asian financial crisis, banking crisis, Berlin Wall, Bretton Woods, British Empire, capital controls, Carmen Reinhart, cognitive bias, cuban missile crisis, energy security, flex fuel, income per capita, informal economy, invisible hand, John von Neumann, Menlo Park, Mikhail Gorbachev, moral hazard, Norbert Wiener, oil rush, oil shale / tar sands, oil shock, packet switching, RAND corporation, Ray Kurzweil, reserve currency, Ronald Reagan, The Wisdom of Crowds, trade route, Vannevar Bush, Vernor Vinge, Yom Kippur War

The share of stock market capitalization controlled by the top fifteen families was 62 percent in Indonesia, 38 percent in Korea, 28 percent in Malaysia, and 53 percent in Thailand. The banking system was also highly concentrated. The market share of the five leading banking institutions was 41 percent in Indonesia, 75 percent in Korea, 41 percent in Malaysia, and 70 percent in Thailand. The political links between business and government added a clear—but unrecognized—moral hazard dimension to the East Asian lending boom. Second, investors were confident that Japan would play a supporting role in the event of any financial problems because of its large investments and bank loans in the region. Japanese banks had 99 offices in East Asia during 1980, 313 in 1990, and 363 in 1994. In 1991, 19 percent of all Japanese international bank lending went to East Asia; in 1994, the share had risen to 26 percent.


pages: 584 words: 187,436