Moral Hazard: Lessons of Parenthood
Perhaps the most egregious consequence of the Mother of All Bailouts (MOAB) is the moral hazard generated on Wall Street. After all, if you make poor investment decisions, now there will be NO consequences as the government will swoop in and take your risk away. Of course, you can keep all the profits in the meantime. Now, you can only do this if you are Too Big To Fail (TBTF); little guys like Lehman Brothers don’t qualify. And don’t even start with regular borrowers who got in over their heads. I’m sure they’ve got to be taught a lesson. Or something.
Now let’s imagine if we ran our households the way our government manages our economy. And I’m not talking about finances here. I’m talking about parenting.
Here’s a situation that arose a few weeks ago: Call it Elrod’s Bad Parenting 101.
My oldest son LOVES trains. And he really loves to watch train videos. To most people, videos of freight trains passing through Nebraska cornfields or Appalachian mountain tunnels would be the perfect sleep agent. But for my sons – ages 6 and 4 – these videos are as thrilling as Christmas morning. And many of these train videos are on YouTube, often with fancy editing and soundtracks.
Anyway, my oldest son (a few weeks ago) was watching a YouTube train video when we called him in for supper. “OK, let me just finish this video. It’s only 45 more seconds and I’ll be right there.” Having hedged our supper time schedule, we said he could finish. Three minutes later, he was still at the computer. “Where are you? The video was only 45 seconds!” Hushed response. Then, I go to the computer and notice that he’s now watching a NEW video that’s 7 minutes long.
“That’s it. We’re turning the computer off and you’re coming to dinner now! And you’re not watching any videos after dinner. You lied to us and said you’d come after your video was over” Tears. BIG tears. Screaming and facial contortions. You can’t take my train movie away!!!
“Come to the dinner table now and sit down.” He doesn’t come. More screaming. Now the neighbors can hear it through the walls. He finally comes in, eats two bites and goes back to crying and screaming about how we CAN’T take his train videos away after dinner.
It goes on like this for an hour. Moping, whining, crying, screaming. And then I relent. I just want him to be quiet. It’s getting close to bed-time and I know he’ll never go to sleep like this. “OK. You can watch just ONE short video before bed.”
Pure glee on his face. He’s gotten a new lease on life. He watches the video, dutifully brushes his teeth, reads his book and goes to bed. All is well. I feel a little guilty for caving in, but at least my headache from hearing him whine is going away.
I forget about the incident. But my son does not. Three days later it comes up again. Almost the same scenario. But then he mutters something unbelievable, “Why are you saying I can’t watch my train video when you’re just going to change your mind anyway.”
OH MY GOD! He just called Mom and Dad out. We vow to ourselves that this requires serious consequences. We not only take his videos away but take them away for the rest of the week and tell him that we are not going to change our minds based on his crying. He actually gets it and realizes that his cynicism got him in trouble. But neither of us parents feel like he’s learned much of a lesson here.
This, folks, is moral hazard. When you spell out consequences for poor behavior and fail to follow through on them, you encourage even more cynicism. You lose credibility.
And that’s what’s happening on Wall Street. Look at the giddiness of Wall Street after hearing of a plan to bail them out of all their bad decisions. It’s just like my son that evening after I gave in and allowed him to watch his video. And it WILL come back to bite us all.
The real lesson on Wall Street is this: consolidate yourself with as many other entities as you can so you can become Too Big To Fail. And then make the most reckless investment decisions you want, because the government will come in and save you when things go bad. You’ll even keep your golden parachute.
Of course, if regular borrowers and homeowners tried this, they’d be foreclosed upon with a lecture about financial irresponsibility. Moral hazard applies to Wall Street. But not to individual people. Sorry. My 6-year old son would understand.
7 Responses to “Moral Hazard: Lessons of Parenthood”
Love it, Elrod. Great article.
Oh, I also wanted to say: this whole idea of “free market” just doesn't work right unless it's actually a free market. I've been saying this for years with regard to the oil industry, every time someone says that the free market will take care of energy policy (when oil gets expensive enough — eh, you know the line). But that doesn't work when you give billions to big oil (or to Wall Street) in tax credits, bail outs, etc. The whole idea of a free market means that the government doesn't do that, and the free market will NEVER take care of energy or anything else if it continues. My point is not that I think a “truly” free market is the best way; instead, I'm merely pointing out how disengenuous it is to have conservatives scream “ah! socialism! boogy boogy!” whenever regulations or government encouragement for new projects is suggested by progressives.
Too big to fail should mean no executives getting millions of dollars in salary, bonuses and benefits.
Actually, you don't even have to spell out unpleasant consequences for failure (a more broad category than wrongdoing). These should be self-evident and the moral hazard is associated with the disappearance of these consequences, that Someone Else will rush to your rescue if you experience adversity or failure (not merely misbehave when warned not to do so).
George — make no mistake. I cannot stand the deadbeat borrowers being bailed out. But in this case, that is an indirect or additional consequence (not unnoticed during this campaign season, obviously — it's an election issue, the economy). The real objective is to bail out the banks; the real, direct, intended-first-and-foremost beneficiaries are the banks and the others on Wall Street who are (too) intertwined with the banks. (I repeat my observation that the current events we see include additional merging of banking with investments and with insurance, and ask rhetorically whether we want to see that.)
Elrod-
If you're having fun now, just wait until the teenage years! Everything becomes a long, drawn out negotiation— I have considered hiring a lawyer to represent my side, or tape recording myself so I remember what I've said in previous arguments.
Just wait until your child decides its completely worthwhile to spend 90 minutes arguing with you whether or not he/she can go to the mall with friends but won't waste 4 seconds changing the toilet paper roll! LOL
In Econ 101, students are taught to avoid arguments that rely on a Fallacy of Composition. Here's a wiki link:
http://en.wikipedia.org/wiki/Fallacy_of_composi…
Your analogy meets this definition, I think, as does any that asks, “What if something big and complex was like something small and simple?”
Another issue I have is the usefulness of simply stating that, “Too big to fail”, is bad, without suggesting what can be done about it. I'd say that the obvious remedies are nonsensical. What criterion could policy makers/regulators use to define “Too big”? How could they know ahead of time that they'd got it right? It would have to be an, essentially, arbitrary, and therefore useless, definition. And, of course, nothing can be done to make sure that a business won't ever fail. So, what's to be done?
There's also this issue
http://www.nytimes.com/2008/09/20/business/20fu…
Here, the problem isn't the size of a company, but the size of a Market. How does one prevent a market from getting, “Too big to fail?”
Lest I be accused of being only a naysayer, let me present another analogy (from Econ 101). Suppose you are a King, setting up a market of arbitrary size and complexity (no FoC!). You take a cut of every transaction. You make your guard and your magistrates available to punish malfeasance and adjudicate disputes. What's your best scheme of management?
I would say that your responsibility, and interest, is to make sure that the market functions; not to decide who the winners and losers will be, or that only the wise, the frugal, the prudent are rewarded. Your only constituent is the market, itself.
Obviously, you want people to be treated fairly, or they'll stop coming, but there are limits to what you can do. Hard fast, unbendable rules, especially any that are based on “market-external” considerations (like the moral and the good) should be avoided. You should, to the extent possible, let the market, itself, set the rules, making sure that you have the resources, including your own treasury, to intervene only when absolutely necessary.
If you're smart, you'll be humble. Market forces are subtle and often inscrutable and are best left alone and not encumbered or directed. This, of course, is one of the main justifications for accepting free market capitalism, with all it's faults and excesses and injustices.
And, one last thing you, the King, have to be willing to accept: the whole thing can fall apart without warning, at any time. Then, you clean up and decide if you want to do it all over again.
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