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Surprise: Moral Hazard Really Was Hazardous

In the midst of the crisis in 2008, the concept of "moral hazard" was a topic of many debates. However, "too big to fail" trumped moral hazard concerns, and the bailouts commenced. Over the ensuing years, we've seen exactly why moral hazard was a significant concern. Nobody learned a darn thing, and the litany of stupid banker tricks has continued unabashed and unabated.

Moral hazard is an economic term with roots in the insurance industry. Basically, it refers to the likelihood that individuals or entities will perform dangerous, risky acts because they know they have protection -- a cushy safety net -- if things go amiss.

Now we have proof: Supplying safety nets to sociopaths is for suckers.

Hey, big boy
The recent scandal regarding Barclays' (NYSE: BCS  ) manipulation of the key LIBOR interest rate is just one more sign of an industry that failed in so many ways in 2008 and somehow never got the memo.

The entire financial industry is apparently full of individuals who are arrogant, wouldn't know an ethical concern if it bit them on the fannies, and are utterly incapable of even writing a decent enough email to leave us all quaking at their evil brilliance. (Widely quoted excerpt from a real Barclays email: "Done... for you big boy.")

Federal Reserve Chairman Ben Bernanke has said the LIBOR rate is structurally flawed, which is unfortunate since it is used as a benchmark for trillions in business and consumer lending. JPMorgan Chase (NYSE: JPM  ) , Bank of America (NYSE: BAC  ) , and Citigroup (NYSE: C  ) are also under investigation for the possibility of similar shenanigans.

The attitude is awfully similar to the ridiculous arrogance and elementary-school-style email missives recently revealed from the investigation of the historic Lehman "the Bros always wins" Brothers bankruptcy: "Absolutely, will and skill always win, and that be us!" And of course, we all know now that not be them.

Granted, Lehman was allowed to fail, but, in a mindboggling turn of events, that wasn't enough to scare the sweet bejesus out of the remaining too-big-to-fail banks that received bailouts.

If you really think about the ramifications of the current LIBOR scandal, we face another crisis of confidence brewing in the financial markets. It's simply not comforting to hear this exchange that Reuters reported took place between a Barclays employee and a British Bankers Association rep:

Barclays employee: "We're clean, but we're dirty clean, rather than clean-clean."

BBA rep: "No one's clean-clean."

Wanted: Serious housecleaning
The dawning idea that maybe none of these folks are "clean-clean" doesn't lend much confidence to our economy and its transactions, does it? Meanwhile, signs mount that Wall Street and big financial companies that also want to walk that walk are simply up to the same-old, same-old.

The disgraceful situation surrounding the Facebook IPO was good example that nothing ever seems to change on Wall Street.

Add that to today's news that the Consumer Financial Protection Bureau's first target is Capital One (NYSE: COF  ) , due to call center vendors who pressured and misled consumers into adding on unnecessary, fee-based services when activating their credit cards. But hey, maybe Capital One needs as much money as it can get its hands on in order to buy up companies like ING's American unit and join the gluttonous ranks of too-big-to-fail banking institutions.

JPMorgan's Jamie Dimon was long viewed as a rare positive figure on Wall Street, but the recent scandal involving the multibillion trading loss has thrown his reputation into a very bad light. It also implies that maybe none of these people have any idea of what they're doing.

Yep, we need some housecleaning. Does anyone have a sand blaster? Economic transactions rely on confidence. This pack of suited-up miscreants aren't doing us any favors, and it's no wonder that regular Americans have little trust for banks, regulators, and big institutions of all kinds.

Furthermore, anyone who has ever entertained the notion that we could ever have anything close to a free market should take their turns occupying Wall Street. Many of the bankers and financiers gain sympathy due to the free market argument, but their basic bottom line is whatever helps their own basic bottom lines. How many times do they have to show they're simply mercenaries before everyone gets it?

No more Monopoly money or "get out of jail free" cards
We now know the true ramifications of the moral hazard that was often mentioned in 2008. Real accountability is sorely needed in an industry that has gone without for far too long.

JPMorgan Chase's recent vow to claw back some executive compensation related to its trading loss is a step in the right direction. However, we need far more clawbacks, far more long-term incentives to do the right things, and far, far more harsh penalties for immoral and illegal actions.

We also need far more jail time for fraud. I'm sure those lovely for-profit prisons would welcome the new business line. A little fear might be good for those who think "dirty clean" is close enough in the financial industry.

Check back at every Wednesday and Friday for Alyce Lomax's column on environmental, social, and governance issues.

Alyce Lomax does not own shares of any of the companies mentioned. The Motley Fool owns shares of Citigroup, JPMorgan Chase, Bank of America, and Facebook. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (16) | Recommend This Article (21)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 19, 2012, at 1:29 AM, DJDynamicNC wrote:

    These guys think they are the scions of capitalism - and in a way, they are. They keep score with money and compete as automatically as they breathe.

    The thing to remember is that that's exactly what unrestrained capitalism is supposed to look like. That's why we have the restraints that we do. Unfettered capitalism is, well... you see exactly what it is every day on Wall Street.

  • Report this Comment On July 19, 2012, at 9:29 AM, BMFPitt wrote:

    If you a give a monkey a gun and it shoots someone, you don't blame the monkey.

    Every member of Congress that voted for the bailouts should be physically kicked out of office.

  • Report this Comment On July 19, 2012, at 11:18 AM, mtf00l wrote:

    Which came first, the monkey or the gun?

  • Report this Comment On July 19, 2012, at 11:23 AM, whereaminow wrote:

    ---->The thing to remember is that that's exactly what unrestrained capitalism is supposed to look like.<-----

    Are you on the same planet I am? Unrestrained capitalism TOOK THESE GUYS DOWN.

    The government, against the will of the people (i.e. the market), bailed them out.

    You have to be completely intellectually dishonest to make such a ridiculous statement.

    David in Liberty

  • Report this Comment On July 19, 2012, at 7:39 PM, Sketch71 wrote:

    Thank you for another thoughful article, Alyce. I think the root of the issue can be found in two words (both of which you used): incentives and accountability.

    However, I think you glossed over a different kind of moral hazard in your previous article "True Leadership: Worth Every Dollar," and I believe these two issues are not unrelated.

  • Report this Comment On July 19, 2012, at 8:47 PM, NeuroProf wrote:

    You go girl.

    Keep sending the memo.

    Sooner or later the message will be read.

  • Report this Comment On July 20, 2012, at 12:09 AM, awallejr wrote:

    +rec. The individual's keep getting away with it because the powers that be prefer fines on corporations over criminal prosecution of individuals.

  • Report this Comment On July 21, 2012, at 11:08 AM, dbtheonly wrote:

    The question 4 years ago still remains: what are the results of allowing these companies to "go down".

    AIG sold insurance & annuities. They go broke. Thousands don't get the check on the 1st of next month. Homeowners suddenly discover that their homes weren't covered by insurance when they burned.

    Capital One does credit cards. They go broke. Millions of credit cards stop working & millions in payments due merchants who accepted the cards the day before are SOL.

    BAC runs a bank. They go broke. Suddenly checks written on their accounts are no good. Millions who have deposits in BAC are SOL. Direct deposit? Automatic payments? Gone. Homes that were about to be bought with a BAC mortgage are un-purchased.

    The list goes on & overlaps in many instances.

    No one wanted to "bail-out" the banks. But many people, looking at the ramifications of not doing so, decided that it wasn't a good option; it was merely the best option. Libertarian fantasies aside; the ramifications of default & collapse were truly horrifying.


  • Report this Comment On July 22, 2012, at 12:50 AM, volker8 wrote:

    Yes Alyce, wall street types are crooks and belong in jail, CEOs are overpaid fiends... *I get it*. How about shaking up the pot a bit and shaking off some of the one-trick-ponyism and writing an expose on the fraud of the green economy and how all these companies are folding left and right like cheap suits after taking in millions in taxpayer credits and subsidies.

  • Report this Comment On July 23, 2012, at 10:38 AM, CMFStan8331 wrote:

    The problem isn't so much the big banks as our response. These large institutions used the threat of another Great Depression to extort a massive government bailout, and the response of the American public has been blind indifference. Most citizens still have no idea why the crisis happened, or how our financial system works in general. Many if not most folks have trouble accurately distinguishing between the millions of dollars volker8 complains about, the billions that went into the bailouts and the TRILLIONS of dollars being managed by the large banks.

    Until politicians actually fear reprisal from the electorate, they will continue to accept money from the big banks to keep the status quo in place, minus a bit of window dressing here and there for appearances. These banks will continue to be too big to fail, and the American people will continue to be on the hook for whatever excesses they may create in the pursuit of profit without concern for moral hazard.

    Unregulated capitalism has very serious problems - that's why we have a regulatory system in the first place. The regulatory system was not dreamed up by misguided liberals who hate capitalism - it was necessitated by hard EXPERIENCE. The system is imperfect, often ineffective and greatly in need of reform itself, but it's infinitely preferable to leaving these gargantuan institutions entirely their own devices.

    Bottom line, our investment banks are still trading like banshees, and they are still far too massive to be allowed to fail.

  • Report this Comment On July 26, 2012, at 3:24 PM, ibuildthings wrote:

    Moral hazard isn't limited to shady banks or investment companies. How many rich bankers can be taxed enough to pay for the moral hazard of millions of "liar loan" homeowners who couldn't make the payments after the bank sold the paper to Freddie Mac or Fannie Mae? And how many homeowners jumped into houses, see their value drop, and just want to leave the lender holding the bag?

    There is one other aspect of "moral hazard". Several California cities are now talking about using eminent domain to take the houses from the lenders and refi at lower rates. Seems nice to the owners, until you realize that no sane Fool would ever risk another nickel with California bonds or real estate, knowing that a politician can rob them at will. America has managed to survive all kinds of disasters and stupid political and personal choices, mainly because any person with money to invest can rely on property rights to be enforced. Take that away, and see how quickly nobody trusts an investment here.

  • Report this Comment On July 26, 2012, at 4:11 PM, kewlness wrote:

    dbtheonly said:

    "No one wanted to "bail-out" the banks. But many people, looking at the ramifications of not doing so, decided that it wasn't a good option; it was merely the best option. Libertarian fantasies aside; the ramifications of default & collapse were truly horrifying."

    Honestly, I would have rather seen the money go toward those who would have been hurt by this than to these "too big to fail" entities.

    None of them were too big to fail. They were too short-sighted to stay viable.

  • Report this Comment On July 27, 2012, at 1:32 PM, ibuildthings wrote:

    Next time, like the intent of the Glass-Stegall act, don't let them get "too big to fail".

  • Report this Comment On July 27, 2012, at 1:34 PM, ibuildthings wrote:

    Another moral hazard: When half the nation pays no federal income tax, but grows to rely on federal subsidies, you get the problem of the tax consumers outvoting the tax producers.

  • Report this Comment On July 27, 2012, at 1:44 PM, ibuildthings wrote:

    The real solution to our budget problems is PARTLY THIS:

    Everybody should pay something in federal tax. We can argue over flat versus progressive: I can make good arguments on either side of that one. But everybody should pay something. Because when you really have YOUR OWN MONEY committed, you care when some politician promises a new entitlement, or a new tax cut, or a new war, or a new anything that affects your wallet.

    Those who have a hard time understanding this, please reread almost any Fool investment letter that discusses the advantage of CEO's who have their own money tied up in their company.

  • Report this Comment On July 29, 2012, at 10:37 PM, skypilot2005 wrote:

    David wrote:

    “The government, against the will of the people (i.e. the market), bailed them out”.

    On July 20, 2012, at 12:09 AM, awallejr wrote:

    “+rec. The individual's keep getting away with it because the powers that be prefer fines on corporations over criminal prosecution of individuals”

    I.M. O., these sum it up.

    In November, we have a chance to vote some who are responsible out of office.


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