Where the moral hazard comes from

By Matt Nolan 26/11/2012

I have a sneaking suspicion that the term moral hazard is getting a bit abused at the moment.  Let’s use the Wikipedia definition:

A moral hazard is a situation where a party will have a tendency to take risks because the costs that could incur will not be felt by the party taking the risk

Cool, and in the case of the bank bailouts that have occurred around the world, who were the people who knew that the cost of their “risky behaviour” would fall on someone else … bondholders.  This is from Garett Jones:

So by their estimate over 90% of the benefit to banks’ balance sheets went to bondholders …

If most political battles need a villain to succeed, it’s easy to see why bondholders have largely escaped the wrath of voters: Bondholders make poor villains.  The bank promised to repay, and now the bank can’t.  The bondholder wasn’t out there making the loans; the bondholder didn’t vote for the directors who led the company to the brink of destruction; the bondholder just handed some cash to the bank and hoped for the best.

Bondholders have had good luck getting government guarantees, and I suspect their luck will continue.  That means rational investors will dump more cash into the megabanks with minimal scrutiny: The megabanks are the new Fannie and Freddie.
The fact is, if we wanted to “get rid of moral hazard” we’d have to accept the inherent riskiness of our lending – we don’t get paid an interest rate for kicks, it covers inflation and a rate of return stemming from lending that has some inherent risk.
The reason economists have generally shown no sympathy for people when the finance companies collapsed here isn’t because we are heartless, it is because people wanted to act as if their lending was riskless.
Remember, if you are complaining about “moral hazard” you are attacking bondholders – not so much the banks (who are easy to demonise because they wear suits), but the people who leant money without considering risk and those who advised them.