Moral Hazard Watch: Getting it right edition

Megan McArdle becomes concerned about the way the term ‘moral hazard’ is thrown about.

Bankers take risk in order to make money, and they control risk in order to avoid losses.  But the losses they are most interested in are not to their shareholders.  Rather, they are worried about the loss of their jobs.  As long as the bank regulators fire any managers who put the bank in receivership, I can see no difference between an unregulated private system without deposit insurance, and a system with.  That isn’t to say that there is enough regulation in either situation.  But if there is a problem, it is that bankers have a socially less-than-optimal risk appetite, or that the punishment for driving a bank into insolvency is insufficient.  The moral hazard from deposit insurance doesn’t much enter into it.

The moral hazard for depositors may be large.  But I doubt it.  Most depositors are not capable of determining whether a bank is faulty or sound, and they weren’t in 1830, either.

The reason that desposit insurance requires tighter regulation is that the government wants to minimize the cost to itself–not society, for whom the losses would be the same whether the government or the bank paid them.  I think this is wise, for many reasons.  But not because of moral hazard.

One thought on “Moral Hazard Watch: Getting it right edition”

  1. In the current climate I think McArdle is right. Given the propensity to pay senior executives tens of millions of dollars a year with no claw-back provision, I’ve seen no suggestion that those who wrecked their banks cared a flying fig about whether the government would guarantee deposits or not.

    As long as the institutions kept making the headline numbers that kept bonuses flowing, they really didn’t seem to give it a thought.

    If, as Kerry Killinger did at Washington Mutual, to pick one out of many, you got a job that paid you $88 million for eight years work and were confident that you could avoid ending up in jail, would you really care?

    Where deposit insurance (or more to the point, solvency insurance) mattered was in the inter-bank market. You had to be able to trust that names were good for the credit exposure you took in buying their paper.

    I think this is the first time that a widespread run on banks has been caused by loss of confidence by wholesale funders, rather than loss of confidence by retail depositors.

    The reflects the change in the nature of banking. Once upon a time customer deposits were more than sufficient to cover the loans that a bank made. Today they may account for half, or even less.


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