The Moral Hazard Of Bailouts

Highlighted stocks include Fannie Mae (FNM), Freddie Mac (FRE), Citigroup (C), General Motors Corp. (GM) and Daimler AG (DAI).

The government bailouts of private industry that we’re seeing now — such as Housing, i.e. Fannie Mae (FNM) and Freddie Mac (FRE); Banks like Citigroup (C); Autos such as General Motors (GM) and Daimler (DAI), and whatever industry is next - are analogous to a child asking their parents for money. Once the wallet or checkbook comes out, they suddenly need more. It is human nature to keep going back to the well until it is dry.

Granted, on the grand scale of the US economy and its major industries, strong arguments are made for bailouts when factoring in the escalating systemic risk and job losses that likely occur from the initial failure of just one group. Therefore, Federal bailouts and the risk of moral hazard are often a necessary evil under the worst of circumstances.

As politicians are prone to do, the solution we see is to “spin-doctor” the issue and call it an “economic stimulus package”; longer names for things are always used to make them sound more benign.

Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. Moral hazard arises because an individual or institution does not bear the full consequences of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to bear some responsibility for the consequences of those actions.

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