Comments on: A “Rational” Explanation of the Financial Crisis

By: Ashwin

Ashwin — Fri, 10 Jun 2011 10:07:32 +0000

Scepticus – you say ““Moral hazard” is a natural expression of the combination of capitalism and democracy.”

I agree with this – my posts draw a lot on Mancur Olson’s work especially in my cronyism posts and his framework explains why this is the case from a political perspective. But recently I’ve begun to think that it is natural even in undemocratic states. China for one is undergoing its own period of crony capitalists taking control and extracting rents.

By: scepticus

scepticus — Thu, 09 Jun 2011 23:54:31 +0000

Nothing wrong with a quick wonk…

Sometimes I think moral hazard is misunderstood sociologically. The hazard is only hazardous while unrealised capital gains in assets remain on the table.

Once peak debt (which I define as the point at which a nominal rate of interest of zero neither causes collapse nor further credit expansion) is realised, then there is no more moral hazard deriving from deposit insurance.

Obviously on the way from there to here, it was a free lunch, but now, as you have pointed out in other posts, real returns and risk premia adjust accordingly such that the all you can eat buffet is gone.

“Moral hazard” is a natural expression of the combination of capitalism and democracy. Any attempt to restore yields by arbitrarily restricting liquidity is not just socially untenable, it just sets up a new free lunch which will get consumed until we get right back where we are now.

By: Ashwin

Ashwin — Thu, 09 Jun 2011 22:32:36 +0000

Scepticus – In my defence, this was my first post! Not that my recent posts are any less wonky I’m afraid. A simpler more concise version of some of the important points in this post is here http://www.macroresilience.com/2010/01/06/implications-of-moral-hazard-in-banking/ .

By: scepticus

scepticus — Thu, 09 Jun 2011 21:40:54 +0000

Great analysis, if a bit wonky!

I agree 100%. It all harks back to two points IMO:

1. deposit insurance
2. an increase in liquidity/connectivity thanks to technology

All government debt whether currency or bonds are money, its all nominal risk free, thus the convergence.

The speed of technological innovation is partly thanks to (1), which of course re-inforces (2), and has quickly led to where we are today.

By: malachi vegas

malachi vegas — Tue, 12 Apr 2011 10:05:37 +0000

You sure go the long way around to spell the word G-R-E-E-D

By: bill

bill — Sat, 18 Dec 2010 15:16:25 +0000

Peruse:
1.to read through with thoroughness or care: to peruse a report.
2.
to read.
3.
to survey or examine in detail.

What does it mean to “briefly peruse”?

By: Ashwin

Ashwin — Sat, 18 Dec 2010 00:25:24 +0000

reader – If you want a shorter summary try this http://www.macroresilience.com/2010/01/06/implications-of-moral-hazard-in-banking/ .

It wasn’t my intention to give a comprehensive story, just a logical argument of how the moral hazard of bank creditor protection is sufficient to account for the facts of how the banks came to invest in the assets they did and lose the money that they did.

By: reader

reader — Fri, 17 Dec 2010 23:26:43 +0000

Briefly perused the article. Put a ‘find’ search in for Fannie Mae or Freddie Mac, with no results. Impressed by the market-speak but what can i take from this article in three sentences?

By: sgt_doom

sgt_doom — Thu, 04 Feb 2010 19:37:48 +0000

What a complete crock! More excuses for all those debt-financed billionaires, and the absence of any economy anymore.

Geez Louise! Enough already, stop the bubbles…stop all the crap!

By: admin

admin — Thu, 07 Jan 2010 00:35:05 +0000

cdo-cubed – thanks for the comment. Much of the skepticism regarding the moral hazard explanation arises from a lack of understanding of the importance of leverage and the fact that it necessitates a highly rated asset portfolio.