Wednesday, September 28, 2011

Market Instability and Moral Hazard

With markets roiling, investors are trying to ascertain whether the Federal Reserve will intervene again to support the capital markets. Some economists name such market behavior as moral hazard "which refers to risky investing done in the hope that government will bail people out of any trouble they get into." The chart at left tracks investments made during the week of August 29th through September 2nd, 2011 and tends to show that investors are motivated to invest based on whether the government will guarantee risk-taking.

Moral hazard"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."

In recent weeks, it appears that investors have returned to risk-taking in hopes of government intervention. During the week tracked above, "the Dow Jones Industrial Average surged 503 points in the first three days of [the] week on hopes Mr. Bernanke would announce some kind of monetary stimulus in Friday's speech [delivered September 2, 2011] 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."

6 comments:

  1. Investors have been making the same types of bets over the last three weeks with regard to the European crisis. However, it is almost impossible to time the swings in the market because they are so irrational. The reports on the European debt crisis seem to change daily making it very difficult to make an informed decision to enter the market. One day it seems as though a Greek default is imminent and the market tanks. The next day there is unfounded hope for another round of bailouts and it soars. Ultimately, I believe that betting on government intervention is a fairly safe bet with large potential gains for those willing to make it. However, a major concern is that the governments of the world may either run out of economic weapons (may be close now) or simply not be able to control the impending crisis.

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  2. Caroline (Memphis Law)October 4, 2011 at 10:24 PM

    I believe that better in government interventions in this economy is not a safe bet with large potential gains. Just recently we were in fear the we would default and the government once again increased our debt ceiling so that we wouldn't default. As Randall states above, a huge fear investors have today is that governments will lose control of this crisis or run out of ways to help large companies out of the crisis. This has been a dwelling problem since 2008 when the market crashed and if we keep relying on government intervention in all that we do ultimately the government will no longer be able to control the market.

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  3. Andrew H - Memphis LawNovember 20, 2011 at 8:15 PM

    The federal government is establishing a dangerous precedent here. If these companies and investment banks are willing to blow money for the sake of risky profits all the while knowing that the government is there to hand them a check at the expense of taxpayers, then what incentive is there to ever act in accordance with common sense?

    If these companies fail, it's their fault. Period. They should not be rewarded for behavior that is reckless and in disregard of established norms in the industry. For every company that goes down, another one can incorporate itself.

    It's acts like these which are fueling the OWS protest movements. Whatever happened to capitalism (long gone, I know)?

    Instead of rewarding reckless risk-taking, why not concentrate on reducing the national debt before China effectively bails us out to the tune of economic ownership?

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  4. People wonder why the poor are getting poorer and the rich are getting richer. I am sure behavior like that discussed above has attributed greatly to the widening of that economic gap. The poor and middle class are having to carry the burden of risky behavior that is not of their own doing.

    Aren't we taught from the beginning that we must take responsibility for our own actions? Maybe we should send these moral hazard investors back to Kindergarten. As the old adage says, with great success comes great responsibility. These investors must accept their gains AND their losses and not attempt to pass the buck to the unsuspecting public. Plain and simple, Congress has outlined regulations of fairness and justice regarding corporations. Allowing investors to rely on a probable government safety net while taking risky measures is neither fair nor striving for justice.

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  5. I agree with the moral hazard argument. They weren't responsible before (ie we're in this mess) so what will make them responsible now?
    I read a really great article about how the U.S. should take a lesson from Iceland. Their banks collapsed and the country's economy was teetering, and now the economy is recovering. It's important to shield taxpayers than the big banks during a financial crisis. From what I gathered, Iceland did this not by choice but by necessity because their governement simply couldn't finance the large bailouts that ours did. But still, regardless of purpose, it worked. We should follow suit, and force creditors to bear the burdens of their bad decision to extend credit to those unable to pay it back.

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  6. I'm a bit puzzled as to why the government might choose to guarantee risk-taking. Investors assess risk, and when higher returns are sought, higher risk is assumed. There are low-/no-risk investing options available, so why should higher risks be guaranteed because of "moral hazard"?

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