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Cracker Squire

THE MUSINGS OF A TRADITIONAL SOUTHERN DEMOCRAT

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Location: Douglas, Coffee Co., The Other Georgia, United States

Sid in his law office where he sits when meeting with clients. Observant eyes will notice the statuette of one of Sid's favorite Democrats.

Monday, August 29, 2011

How soon we forget; deja vu; and I have been fussing to whomever would listen: Fed Faces Old Foe as Hazard Returns

From The Wall Street Journal:

To seasoned investors, last week's sharp market swings were a fresh reminder of a problem tormenting financial markets: moral hazard.

Stocks jumped, then sank and then rose again, as investors tried to bet on whether the Federal Reserve is going to intervene again to support financial markets.

Economists sometimes refer to that kind of market behavior as moral hazard, which refers to risky investing done in the hopes that government will bail people out of any trouble they get into.

It was a big issue after the 2008 collapse of Lehman Brothers Holdings Inc., when the government bailed out several other banks. It created the idea that they were too big to fail and that their executives and bondholders would be protected from their own mistakes.

Today, investors have returned to risk-taking in hopes of government intervention, and newly confident banks are protesting efforts to increase regulation.

In an interview, former Fed Chairman Alan Greenspan said government intervention can create moral hazard.

"Oh, I think so," he said. While he declined to comment on current monetary policy, he mentioned "too big to fail" as an example. Government actions almost inevitably have unintended consequences, he said.

The Dow Jones Industrial Average surged 503 points in the first three days of last week on hopes Mr. Bernanke would announce some kind of monetary stimulus in Friday's speech in Jackson Hole, Wyo. It fell 171 points Thursday on fears he wouldn't. Then it rose 134.72 points Friday on hopes that the Fed's decision to expand its September meeting to two days was a signal that it was preparing to discuss some kind of stimulus.

Moral hazard may be an even bigger issue in Europe. Ratings firms say ratings of European bank bonds depend on the idea that governments will protect the banks from default on European government bonds.

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