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2008: The Year of Moral Hazard

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In 2008, many of us got a crash course on the term "moral hazard," whether we wanted it or not. At least once a week, it seems we're reminded of this term's importance, and why our economic freedom is seriously endangered by current policies that prop up failing, mistake-ridden companies and industries. 

"Moral hazard" is an economic term that originated from 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 safety net -- if something goes awry. The "too big to fail" motif so prevalent in 2008, and so linked to the idea of "moral hazard," exemplifies the slippery slope we've found ourselves on.

Lining up for help
Many of us worried that the original Troubled Asset Relief Program (TARP) bailout would be a sucker punch, creating ever more expensive and dangerous moral hazards. Sure enough, more and more companies have been lining up for TARP assistance, many of which don't seem to represent the essential functions government wanted us to believe TARP was intended to protect.

Apparently, after enjoying a decade of risk, greed, and gluttony, nobody wants to face the miserable but necessary hangover that inevitably follows. American Express (NYSE: AXP  ) has been approved for $3.39 billion in funds from TARP. General Motors' (NYSE: GM  ) GMAC will receive another $5 billion. General Electric (NYSE: GE  ) got a debt backstop, too. Commercial real estate companies have recently joined the cacophony of companies desperately braying for government financial help.

Ford (NYSE: F  ) , General Motors, and Chrysler may be too dumb to survive, but the government has also deemed them too big to fail.  And in a really bizarre twist, even farm equipment maker Deere (NYSE: DE  ) recently got a debt backstop from the government.

What's next -- the newspaper industry, perhaps? I guess companies like Tribune or Gannett (NYSE: GCI  ) could argue that our country needs newspapers -- even if nobody really wants them, at least in their fee-based, newsprint form. (And gosh, USA TODAY even has "USA" in the title! Can't let that fail, right? We'll worry about the pitfalls of state-run, state-funded media later.) We Fools have even begun to joke that Sirius XM (Nasdaq: SIRI  ) is too big to fail, too.

You can argue that almost anything is too something to fail. But all joking aside, we are in trouble.  

The devil's in the details
"Moral, adj. Conforming to a local and mutable standard of right. Having the quality of general expediency."
- Ambrose Bierce, The Devil's Dictionary

I'd say the sarcastic definition above is spot-on these days. In the wake of our recent financial meltdown, so many people seemed to panic, swiftly sacrificing principles and common sense alike. Fear of consequences has pushed government and business into a treacherous tangle of safety nets and "expediency."

As much as it pains so many policy-makers to reward failure or bad action, it seems that, darn it, it's just got to be done to save us all. Never mind the ominous idea that we could fail like Japan, with a bunch of zombie corporations staggering around for a decade.

I think we've been mugged and conned. The risk of the wholesale destruction of the American economy is most certainly real. When businesses face no risk of failure, they're free to do almost anything they want, however disastrous. That's the essence of the current danger.

Congressman Ron Paul, R-Texas, recently posted on his blog about the Big 3 bailout, writing that freedom includes the freedom to fail. This is important and very true. On our present course, government takes funds from companies and individuals who did the right thing to reward the failure and mistakes of others. That ill-advised principle makes these times morally hazardous indeed -- for our economy, for our basic economic principles, and ultimately for our freedom.

The bailout buck must stop -- the sooner, the better. Let's just hope that when it does, it's not too late for the rest of us.

American Express is a Motley Fool Inside Value recommendation. The Fool owns shares of American Express. Try any of our Foolish newsletter services free for 30 days.

Alyce Lomax does not own shares of any of the companies mentioned. The Fool has a disclosure policy.

Read/Post Comments (6) | Recommend This Article (38)

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  • Report this Comment On December 30, 2008, at 7:19 PM, MKArch wrote:


    I think the fact the two industries most culpable in the current mess no longer exist, subprime lending and investment banking kind of undercuts your argument that no one learned any lessons and there were no consequences for stupid behaviour.

    I don't think you could find anyone involved in this whole mess who could honestly say it was all worth it and if I could do it again I would. The downside eclipsed what ever upside there was during the bubble.

    They get it Alyce, making loans to people without the ability to pay them back was a stupid idea. Making loans to people with a track record of not paying their loans back was a stupid idea. Making loans to people you know are lying on their application was a stupid idea. Making loans to degenerate gamblers was a stupid idea.

    With the exception of the millions of people who never should have gotten a mortgage in the first place that have suddenly become "victims" nobody benefited from this disaster. After hundreds of billions in write offs and losses eclipsing what ever profits were made in the bubble the companies that do eventually survive this mess will not make these mistakes again in our lifetime. Even if they were stupid enough to try it again who will buy the loans from them?

    I don't blame the government for trying to soften the landing. I'm satisfied that making stupid loans was a bad idea has been driven home by now, we don't need to worry about moral hazard and can concentrate on some financial triage. To not help those who can be helped would be just vindictive at this point. The worst offenders are gone already.


  • Report this Comment On December 30, 2008, at 10:06 PM, TDRH wrote:

    Great post again. The situation reminds me of the story of the grasshopper and the ant, only with a twiist that the ants get taken to the cleaners.

    I agree with you that the correction needs to occur and the bailouts must end. As a simpleton however I am disappointed that we are not seeing any perp walks. I believe mozillo the tanned one would do it again. These were the country's best and brightest that have driven the global financial sector to the brink of collapse. GS was creating investment vehicles to short the very credit instruments they were selling. This is not a conflict of interest?

    Not only must the bailouts end, but steps need to be taken to ensure this dies not happen again. Without the threat of punishment, the rape of our futures to benefit a chosen few will continue.

    Great article again.

  • Report this Comment On December 31, 2008, at 10:49 AM, RHaganC wrote:

    Fantastic Article.

  • Report this Comment On January 01, 2009, at 12:57 PM, todayisagift wrote:

    The articles and responses are all well-considered points of view, and readers are fortunate to have both sides of the dilemma so cogently explained.

    As an individual, I feel powerless to change this situation. Our sole debt is a 30-yr. fixed mortgage, which we have been faithfully paying for many years. With retirement (from an average position) still more than a decade away, our 401(k)s remain untouched except by the effects of the market; so we're down more than half and the future looks bleak, financially. However, we're not selling.

    So this is a lot of "not changing anything" while the dramatic changes in the economy swirl around us. My fear grows, our investments shrink. How can individuals like me make any difference or have our voices heard in this debacle?

  • Report this Comment On January 04, 2009, at 3:34 AM, MFMerlin wrote:

    Excellent article Alyce (again)!!! With tongue in cheek I guess I might mention that it looks like the States themselves will be the next in line looking for help from the Federal government - with my own Commonwealth's governor, Deval Patrick, suggesting assistance in the amount of a(nother) trillion dollars. Call me stupid, but does this not approximate as closely as possible the phrase "borrowing from Peter to pay Paul" ...........

    Two thoughts if you would care to comment on them; As Todayisagift also wrote - "How can individuals change any of this?", and;

    What would your prognosis for gold/gold stocks be, should all of this bailout stuff continue?

  • Report this Comment On January 08, 2009, at 2:40 PM, nerd1951 wrote:

    Government has been in the bailout business for over 70 years. Ever heard of farm subsidies? The reasoning then was that we had to save small family farms. (Too small to fail?) We still have these programs but now they are used by large agra-business to fleece us tax payers.

    Sadly bailouts are nothing new and like most government programs - nothing is ever temporary except maybe surpluses.

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