Category Archives: Moral Hazard

Statement Concerning Too Big To Fail (TBTF)

I found the Opening Statement at the Full Committee Hearing on ‘Too-Big-to-Fail’ Post- Dodd-Frank, made yesterday (June 26) by The Committee On Financial Services’ Chairman Hensarling, to be notable.

While I don’t necessarily agree with everything said in this Opening Statement – or with all aspects of the following excerpts – here are the excerpts I found most notable:

Today, though, there is a growing bipartisan consensus that the Dodd-Frank Act regrettably did not end the Too Big To Fail phenomenon or its consequent bailouts.


Ending taxpayer funded bailouts is one of the reasons why this committee has invested so much time on Sustainable Housing Reform. The GSEs, Fannie and Freddie, are the original Too Big to Fail poster children, yet were untouched and unreformed in Dodd-Frank. They have received the largest taxpayer bailout ever – nearly $200 billion. Along with the FHA, the government now controls more than 90% of our nation’s mortgage finance market with no end in sight.


Regrettably, Dodd-Frank not only fails to end Too Big to Fail and its attendant taxpayer bailouts – it actually codifies them into law. Title I, Section 113 allows the federal government to actually designate Too Big to Fail firms – also known as SIFIs. In turn, Title II, Section 210, notwithstanding its expost funding language, clearly creates a taxpayer funded bailout system that the CBO estimates will cost taxpayers over $20 billion.

Designating any firm Too Big to Fail is bad policy and worse economics. It causes the erosion of market discipline and risks further bailouts paid in full by hardworking Americans. It also becomes a self-fulfilling prophecy, helping make firms bigger and riskier than they otherwise would be. Since the passage of Dodd-Frank, the big financial institutions have gotten bigger, the small financial institutions have become fewer, the taxpayer has become poorer, and credit allocation has become more political.

my comment:

I’ve previously discussed “Too Big To Fail” and “Moral Hazard” in numerous posts.

I continue to believe that “Too Big To Fail” (TBTF) and “Moral Hazard” issues are of paramount importance.  My analyses indicate that these issues lack both recognition and effective remedy, which is very unfortunate.


The Special Note summarizes my overall thoughts about our economic situation

SPX at 1613.93 as this post is written

Stiglitz Interview – Notable Excerpt

Today’s Barron’s has an interview with Joseph Stiglitz.  I found his answer to the following question to be an interesting perspective:

Before we talk about all that, what are the most surprising developments since you won your Nobel Prize?

Surprising to whom? The bubble episode surprised so much of the world—Greenspan and Bernanke believed that markets knew how to handle risk, self-regulation was adequate and the banks had incentives to manage risk and so forth and so on. We saw that it isn’t true—in a very dramatic way. That wasn’t surprising to me because my Nobel Prize was about the economics of information and this notion of agency theory, that the people who are making decisions do not necessarily reflect the interests of those who they are supposed to be serving.

The kind of incentive schemes that were being employed by firms, banks and financial institutions weren’t consistent with any model of rational behavior other than exploitation. If you believe incentives matter, something untoward was going to happen. At the level of markets, securitization had some fundamental flaws, because you didn’t have the incentives to monitor or manage them and created a moral hazard. To our leaders and erstwhile gurus, it came as a very big surprise. You have a market economy where incentives do matter, but in which they aren’t always aligned.


The Special Note summarizes my overall thoughts on our economic situation

SPX at 1273.72 as this post is written

Larry Kudlow Comment On January 13 Regarding “Too Big To Fail”

On Thursday, Larry Kudlow interviewed Rep. Spencer Bachus on CNBC.

I found one comment Kudlow made, starting at the 6:17 mark,  to be especially notable:

“Many people believe that the top 5,6,8 banks are in fact too big to fail and constitute government sponsored enterprises in effect.  That is an unfair advantage in the credit markets that is sort of like Fannie and Freddie all over again…you know private profit but public taxpayer risk….”

My comment:

As time goes on, the issues of “Too Big To Fail” and “Moral Hazard” are being discussed less and less, which is unfortunate.  There are many aspects of each of these concepts that are profoundly important to our economic system.

I’ve previously discussed “Too Big To Fail” and “Moral Hazard” in numerous posts…


A Special Note concerning our economic situation is found here

SPX at 1293.24 as this post is written

SIGTARP Comments

I found some interesting comments in the SIGTARP January 30 2010 Report to Congress:

From the Executive Summary, which begins on Page 5:

“Many of TARP’s stated goals, however, have simply not been met. Despite the fact that the explicit goal of the Capital Purchase Program (“CPP”) was to increase financing to U.S. businesses and consumers, lending continues to decrease, month after month, and the TARP program designed specifically to address small-business lending — announced in March 2009 — has still not been implemented by Treasury. Notwithstanding the fact that preserving homeownership and promoting jobs were explicit purposes of the Emergency Economic Stabilization Act of 2008 (“EESA”), the statute that created TARP, nearly 16 months later, home foreclosures remain at record levels, the TARP foreclosure prevention program has only permanently modified a small fraction of eligible mortgages, and unemployment is
the highest it has been in a generation. Whether these goals can effectively be met through existing TARP programs is very much an open question at this time. And to the extent that the Government had leverage through its status as a significant preferred shareholder to influence the largest TARP recipients to carry out such policy goals, it was lost with their exit from TARP.”


“….The substantial costs of TARP — in money, moral hazard effects on the market, and Government credibility — will have been for naught if we do nothing to correct the fundamental problems in our financial system and end up in a similar or even greater crisis in two, or five, or ten years’ time.  It is hard to see how any of the fundamental problems in the system have been addressed to date.

• To the extent that huge, interconnected, “too big to fail” institutions contributed to the crisis, those institutions are now even larger, in part because of the substantial subsidies provided by TARP and other bailout programs.

• To the extent that institutions were previously incentivized to take reckless risks through a “heads, I win; tails, the Government will bail me out” mentality, the market is more convinced than ever that the Government will step in as necessary to save systemically significant institutions. This perception was reinforced when TARP was extended until October 3, 2010, thus permitting Treasury to maintain a war chest of potential rescue funding at the same time that banks that have shown questionable ability to return to profitability (and in some cases are posting multi-billion-dollar losses) are exiting TARP programs.

• To the extent that large institutions’ risky behavior resulted from the desire to justify ever-greater bonuses — and indeed, the race appears to be on for TARP recipients to exit the program in order to avoid its pay restrictions — the current bonus season demonstrates that although there have been some improvements in the form that bonus compensation takes for some executives, there has been little fundamental change in the excessive compensation culture on Wall Street.

• To the extent that the crisis was fueled by a “bubble” in the housing market, the Federal Government’s concerted efforts to support home prices — as discussed more fully in Section 3 of this report — risk re-inflating that bubble in light of the Government’s effective takeover of the housing market through purchases and guarantees, either direct or implicit, of nearly all of the residential mortgage market.

Stated another way, even if TARP saved our financial system from driving off a cliff back in 2008, absent meaningful reform, we are still driving on the same winding mountain road, but this time in a faster car.”

back to <home>

SPX at 1097.28 as this post is written

“Too Big To Fail”

The term “Too Big To Fail” is heard frequently. 

However, for all of the talk regarding its danger, very little if anything has been done to rectify the condition. 

As seen in The Wall Street Journal of December 16, p C18, “The top four banks have combined assets of $7.4 trillion, or 56% of the U.S. banking sector’s total.  In 2000, the top four’s $2 trillion of assets accounted for 35% of the total.”

“Too Big To Fail” has many adverse consequences.  Perhaps the most serious is that it potentially fuels moral hazard.

back to <home>

SPX at 1102.47 as this post is written

Moral Hazard Speech

Here is a link to an October 20 speech given by Mervyn King.  The speech speaks of the concept of Moral Hazard:

Although there are various notable passages, I found this line perhaps most interesting:


 “The massive support extended to the banking sector around the world, while necessary to avert economic disaster, has created possibly the biggest moral hazard in history.”

I have commented on Moral Hazard previously on this blog.  As I have noted, there has been very little (especially relative to the size of the issue) commentary or attention given to the issue.  I believe the Moral Hazard issue is of the greatest importance. 

Moral hazard should have been addressed via credible policy many years ago.  I am certain that by neglecting this issue we will see immense damage.


SPX at 1098.22 as this post is written 

Bank Bonuses and Broader Implications

I’d like to make a brief comment about the “bank bonus” story that came out a few days ago.  Here is one article on it, titled “Bank Bonus Tab: $33 Billion” from The Wall Street Journal on 7-31-09:

Needless to say, it seems outrageous that such bonuses, in said amounts, were paid out so broadly in 2008 given the overall situation – especially for those banks that would have otherwise collapsed absent tremendous levels of government intervention.  Of course, there may be some mitigating factors or legitimate reasons for at least some of these bonuses, but I have yet to read or hear of any.

It seems as if this bonus issue should have been adequately addressed before any intervention funds were allotted to the various banks.

Overall, I think the two major issues concerning these bonuses are Fairness, as well as the impact on Moral Hazard.

As I have alluded to previously (on a 6/21/09 post) the Moral Hazard environment that has been created and perpetuated over the last few years is truly epic and mind-boggling.  It appears as if this Moral Hazard situation has only been exacerbated with the Bank Bailouts that have occurred during The Financial Crisis.

Moral Hazard implications are very important, even if (seemingly) few people really want to think about them.  Moral Hazard has many types of direct and indirect effects ranging from our potential National Debt to issues regarding Sustainable Prosperity to issues concerning Fiduciary Responsibility.  Part of the challenge, and importance, of crafting appropriate national policy is to consider, in totality, how the economic environment will be impacted by various government actions.  To ignore, or downplay, Moral Hazard implications is a serious mistake.

SPX at 1002.63 as this post is written

Moral Hazard Wonderland

To date, I haven’t written or otherwise commented about the issue of Moral Hazard.

Perhaps the main reason is that I am afraid if I start writing about it, I may never stop…

Needless to say, the issue of Moral Hazard and its implications are massive, and just seems to grow with time.  It seems as if the issue has taken a “back seat” for quite a while now, and, paradoxically, seems to have become even less of an issue, policy-wise, since The Financial / Economic Crisis began.

The following is an interview with FDIC Chair Sheila Bair which discusses the Moral Hazard topic and related issues:

SPX at 921.23 as this post is written