Moral hazard

There is a consensus among pretty much every mainstream politician from every party in the UK and most other countries in the West (no counting the Greens as mainstream) that the financial system we use is the best one available. Which is to say, there are not many Marxists left, besides good old Tony Benn.

Obviously the system has its problems – the two of the greatest concern to me being income inequality and environmental impact – but most would argue the system can be adapted to meet those challenges. I have my doubts – especially in the former case – I see no evidence that anyone has thought of a solution to the growing disparity between the poor and the rich. The “rising tide lifts all boats” argument is all well and good, but when you see the social degradation that seems to be an inevitable consequence of financial success you have to wonder whether things can keep going as they are.

But there is another well known problem with capitalism: moral hazard – the idea that capitalists, risk takers, the people with the money get paid to take risk and, in many cases, make a load more money, while when things go spectacularly wrong, (when it is the shirts off our backs they lose, not just their own) it is the taxpayer who bails them out. This is obviously an especially pertinent issue at the moment with what is going on with Fannie Mae, Freddie Mac and potentially dozens of other financial institutions in the US and Europe.

This problem inevitably leads to calls for greater accountability for these capitalist fat cats running the world’s banks, energy companies, mortgage lenders and others who put the system at risk. “Lock them up and throw away the key,” people cry with righteous indignation. It is a nice idea, in many ways: we are not asking for every bad executive decision to be met with a prison sentence, but for those taking excessive risk, knowing full well that they will be bailed out if things go wrong, to think twice about it.

Except we might as well hope for George Bush to be tried for war crimes in front of a jury comprising Iraqi widows. Because neither is going to happen. And what's more, it can’t really happen. There are too many executives from too many companies representing too large a proportion of the business world implicated in said excess. Letting them fail would do more harm than good, so you have to concentrate on trying to get it right before it happens again (in the next cycle). Sadly, by then people will find ways to argue things are different and the good times will lull people into forgetting all about this. It is how economic cycles work.

Apologists would also argue that, taken on a net basis, the system still works. It is high unlikely that more will be lost in this downturn than was earned during the bull market. If you look at the stock market since its inception, over practically any 20 year period the equity market has failed to make money – one notable exception being one 20 year period straddling the Depression (which goes to show that what is unlikely is not impossible).

At certain times things go wrong and the government has to step in. But for the most part the system generates wealth for people and governments alike. The trick will be to restrain the excesses - to create that magic wand that will allow the markets to be free on the upside and the down, but without putting the whole system at risk. But nobody – to my knowledge at least – knows how that can be achieved.

Who knows, this might even go some small way to redressing the inequality question: if the rich are allowed to lose all their money when something goes wrong, and the taxpayers’ money is spent more on bettering the lot of the poor than on reimbursing investors who lose their money in these financial crises, that can only be a good thing. It might also be an amusing spectacle, watching the rich lose all their money. Who knows, if someone can think of a way of turning it into a reality TV show, it might even happen.