Policymakers refuse to do anything about moral hazard, because it’s so politically popular. Not just in banking, but also in federal flood insurance, health care, and many other areas.
Government regulation in finance is justified as reducing risk. But the whole point is to allocate credit to favored uses. As part of that, some risks get subsidized.
Wait, how was 2007/2008 financial panic about loans by small banks to property developers? I thought it was about sub prime, and big lenders being insolvent, with some help from investment banks in securitizing home loans and selling them off. And the S & L meltdown was about S & L s being stuck with low yielding long term home loans in a time of rising interest rates and inflation ( and deregulation of deposits) seeking to in effect to do “joint ventures” with real estate developers, who were often related. Some neither was really about small banks loans to real estate developers (unless you count S & L s) as small banks. Small banks make loans to real estate developers and property owners because that allows them to make larger loans with decent security, and depends on personal relationships where they have an advantage. Big banks make more consumer loans which rely on technology where they have an advantage over smaller banks. And for individual bank failures, the losses are paid for by FDIC insurance, where is covered by dues from the banks, not the taxpayer.
Not sure that “moral hazard” is really the issue. Or at least would like some evidence to support that finding rather than mere assumption.
Sumner has written exhaustively on his pet thesis that moral hazard is the root of all evil.
But insurance exists because of the existence of foreseeable risks of loss.
A typical definition of moral hazard states “In economics, moral hazard occurs when someone increases their exposure to risk when insured, especially when a person takes more risks because someone else bears the cost of those risks.”
For moral hazard to be a culprit in a failure one would need to demonstrate that risky behavior increased over the norm. I don’t think Sumner ever manages to pull that off persuasively.
Sumner gives some commercial real estate failures as as example. How do we know that OZK’s investments were extraordinarily risky? We don’t. It makes perfect sense that firms would specialize in commercial real estate. Anyone can go to the ABA’s web page and read the Commercial Real Estate FAQs to get an idea of the layers and layers of lender protections built into a typical CRE loan or mortgage. People invest in such firms because they are typically thought to be a good wedge against the volatility of the stock market. And CRE transactions are typically secured with actual assets. Secured lending is generally the safest lending. Losses will occur from time to time, but are such losses actually the result of excessive risk taking?
I suspect that the multiplier effect of federal insurance of bank loans for commercial real estate is about the highest among any government programs. Stuff gets built, more people work, more people pay taxes. More than can be said for most other government programs. Maybe Sumner would like it better if we just called it a grant. And I feel as if I can guarantee you that research funded with federal grants is more prone to moral hazard in the form of sloppy methods and misleading grant applications than any commercial real estate loan application.
If you really wanted the government to get out of the insurance business, you would first start with student loans. $1.5 trillion in non-performing loans. All to prop up a corrupt, tax-exempt industry.
I have no objection to government getting out of the insurance business all together.
The less it spends the better. I get the feeling though that Sumner is pandering to the type of crowd for which “business,” “commercial,” and “profit” are words denoting evil.
Government regulation in finance is justified as reducing risk.
The average appreciates stability in our lives and endless or huge financial crisis are exceptionally painful. Again, it is awfully hard to convince the average person capitalism is working great with 20% unemployment like 1932.
GOOD government regulation in finance is justified as reducing risk.
Finance is one of the most regulated industries there is, but 2008 happened. The solution is not to pile on more regulations but to have good ones. Which may mean fewer.
I do wonder how financial crime has changed since the introduction of AML and KYC regulations, and what the factors of correlation are in the change.