Moral hazard

I've always felt that the problem of moral hazard has been exaggerated. But this time, no.

Here's Peter Bernstein, dean of finance economists, on moral hazard in his latest newsletter:

For as long as I can remember, every government or Fed bailout has elicited cries of alarm about moral hazard: "If we bail out today the miscreants who overreached in risk-taking, then we can expect a huge increase in overreaching miscreants tomorrow. And an even larger gang next time around." Why not? Why not make high-risk bets when you are confident the government will restore you to life even if you end up financially dead?

The government is now indulging in moral hazard in extreme orders of magnitude. How do we control the consequences? When all bad bets are made good by the government, or at least settled somewhere over zero, how do we prevent a replay of the light-hearted risk-taking of this era next time prosperity takes hold? Jiggling with the fed funds rate is hardly a barrier. The implication is that today's crisis and tomorrow's bailout could be just a minor prelude to a more grandiose climax somewhere in the not-too-distant future.

One implication is that to deal with situation, and forestall an even bigger disaster, the regulatory overhaul will have to be dramatic. It can't be regulatory changes at the margin. And the regulations can't be written by Wall Street and their well-paid lobbyists.

Another implication is that both Obama and McCain are going to have to rewrite their tax proposals. Any fiscal policy proposal has to take into account that we've raised the national debt by $6 trillion in just a few months. The fiscal tab is likelty to get bigger.