Video: “Moral hazard” and the root of the financial collapse
posted at 9:30 am on January 15, 2010 by Ed Morrissey
Why don’t insurance companies sell policies to auto owners that pay $100,000 if your 1985 Yugo gets totaled? They understand that paying more than the value of a car for its destruction would mean that people would have an incentive to destroy them, a rather obvious rhetorical example of moral hazard. Moral hazard undermines well-functioning markets by introducing artificial insulation from risk. For instance, normally lenders are discouraged from offering loans to people who can’t afford them, because lenders don’t want to get stuck with an unserviceable mortgage and a foreclosed property that will sell far below their investment. But what happens when government intervention interferes with that natural balance, for instance, when government simply buys up loans by the trillions so lenders don’t have to worry about defaults?
We get 2008, that’s what, as the Center for Freedom and Prosperity reminds us in their latest Econ 101 series:
This often happens when government intervention lets people take risks while having little or no skin in the game. Housing policies, for instance, subsidized mortgages, thus enabling irresponsible borrowing and leading to bubbles and bailouts. Politicians may be setting the stage for the next crisis with a too big to fail policy that will subsidize the biggest financial institutions.
CFP is correct to call this Econ 101. Does it worry anyone that our current political leadership still cannot pass this course?
The Justice Department is beginning a major campaign against banks and mortgage brokers suspected of discriminating against minority applicants in lending, opening a new front in the Obama administration’s response to the foreclosure crisis.
Tom Perez, the assistant attorney general for the department’s Civil Rights Division, is expected to announce Thursday in New York that the administration is creating a new unit that will focus exclusively on unfair lending practices. …
While past lending discrimination cases primarily focused on “redlining” — a bank’s refusal to lend to qualified borrowers in minority areas — the new push will instead center on a more recent phenomenon critics have called “reverse redlining.”
In reverse redlining, a mortgage brokerage or bank systematically singles out minority neighborhoods for loans with inferior terms like high up-front fees, high interest rates and lax underwriting practices. Because the original lender would typically resell such a loan after collecting its fees, it did not care about the risk of foreclosure.
It is a rarely used theory, and it carries political risks. Some critics have contended that government rules pushing banks to lend to minority and low-income borrowers contributed to the financial meltdown. The campaign could rekindle that debate.
“They encourage lenders to make risky loans for reasons such as diversity, and then when lenders have a problem because they made too many risky loans, they condemn them for that,” said Ernest Istook, a fellow at the conservative Heritage Foundation and a former Republican congressman from Oklahoma.
It’s the CRA all over again. How long before Congress demands that FHA lenders start issuing mortgage-backed securities to cover its questionable loans? We’re already there.
Update: Reader Evan M notices that the first paragraph had some consistency problems — I’ve cleaned it up.
Blowback
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They don’t want to understand Econ 101. They want to buy votes, and Obambi wants to execute Cloward-Priven until the economy collapses and he can nationalize the economy completely.
Wanderlust on January 15, 2010 at 9:37 AM
To a liberal, the past never matters, because “This time, we will get it right”.
MarkTheGreat on January 15, 2010 at 9:37 AM
I’ll say it again: Ludwig von Mises makes the point in his The Anti-capitalist Mentality, that there’s no sense in making any distinction between socialism and communism.
I think he’d agree that there’s no sense of making any distinction between today’s Democrats of socialism.
Akzed on January 15, 2010 at 9:38 AM
Uh…because liberals don’t care about economics, they care about power?
Bishop on January 15, 2010 at 9:38 AM
Government intervention distorting the free market precipitated the financial crisis, NOT lack of regulatory oversight.
Chip on January 15, 2010 at 9:39 AM
Excellent primer.
The entire Obama administration and its lap dog congressional cronies are essentially a “Moral Hazard”.
rplat on January 15, 2010 at 9:42 AM
Worried? No, not worried. Scared & frustrated, yes.
rbj on January 15, 2010 at 9:42 AM
We’re approaching a financial earthquake . . .
Skandia Recluse on January 15, 2010 at 9:44 AM
A Haiti economy…we will be pulling bodies out of the rubble for decades…
right2bright on January 15, 2010 at 9:48 AM
Oh, ain’t that the truth!
(That’s going in my quotation file if you don’t mind)
That’s why a lot prefer using the term ‘National Socialists’ when referring to the Democrats.
They appear to have a goal of Nationalizing everything in the nation, and their political philosophy is Socialism, hence, ‘National Socialists’ .
Chip on January 15, 2010 at 9:48 AM
Unlike the T.V. anchor who thinks Lincoln is one of this county’s “Founding Fathers”, Niki is a brilliant brunette
MSGTAS on January 15, 2010 at 9:49 AM
The shaking began one year ago and will continue unless and until the populace removes its collective head from its collective azz and vote these b*stards out. As more and more become dependant upon the largess of government for their very existence, the possibility of meaningful change diminishes. We are witness to the destruction of the American experiment.
Crusader Rabbit on January 15, 2010 at 9:52 AM
Crazy is doing the same thing over and over and expecting a different outcome. GM anyone?
flytier on January 15, 2010 at 9:53 AM
I’d like to send her a letter offering her a million dollars if she can find Lincoln’s name anywhere on either the Declaration of Independence or the Constitution. But her staff would just put it in the ’round file’. |-p
Dark-Star on January 15, 2010 at 9:56 AM
Seriously, the Center for Freedom and Prosperity has put together a fine piece. It is essential to educate the mind numbed left that before you begin messing with other peoples money you must understand the basic concepts of economics.
I suggest that dem running for public office, to stop doing what Dems have done for years – selling U.S. citizens short on their ability to deal with the real problems facing U.S..
MSGTAS on January 15, 2010 at 9:57 AM
Liberals don’t understand economics. Obama wants to redistribute risk by taxing banks that are large. If a loan fails, it should only hurt the lender. Obama will buy the bad debt and make uninvolved banks pay.
seven on January 15, 2010 at 9:57 AM
It’s worse than what is being described in this video. The ultimate “moral hazard” is Buy-and-Hold Investing. What we want is for the market to function properly. For that to happen, people need to understand that stocks offer a far worse long-term value proposition when prices are high than they do when prices are reasonable. If people knew this, then most would naturally lower their stock allocations when prices rose to insane levels. Buy-and-Hold encourages investors not to do this, making it impossible for the market to bring prices back to where they need to be except through a crash. The Stock Selling Industry has been spending millions promoting Buy-and-Hold for three decades now and the mainstream press has failed to warn us that this was certain eventually to bring on an economic crisis.
For those interested in a more in-depth description of the problem, I have written a Google Knol entitled “Why Buy-and-Hold Investing Can Never Work”:
Why Buy-and-Hold Investing Can Never Work
Rob
Rob Bennett on January 15, 2010 at 10:03 AM
Obama has at least stimulated the market for remedial economics lessons.
Good video.
forest on January 15, 2010 at 10:03 AM
With our tax dollars and have been very good at doing so but maybe, just maybe, people are waking up if the situation in MA is any indication.
Awesome video. Subscribed.
Yakko77 on January 15, 2010 at 10:09 AM
Who is this racist “Niki”?
PaCadle on January 15, 2010 at 10:13 AM
I wonder how many of our fine Institutions of Learnin’ have professors teaching this topic in their Econ 101 classes.
gregbert on January 15, 2010 at 10:32 AM
BINGO!!!!!!!
capejasmine on January 15, 2010 at 10:45 AM
Moral hazard=the consequences of intentional negation of individual responsibility.
Entitlement=government taking personal responsibility away=loss of the ability for personal judgment=loss of reason, other than as it pertains only in selfish terms.
Speakup on January 15, 2010 at 10:54 AM
The Marxistscan pass the course.
They don’t care.
They know that if the government can sieze control of 50% of the economy that there is no going back.
notagool on January 15, 2010 at 10:55 AM
I wonder what Allah thinks about that.
Count to 10 on January 15, 2010 at 10:57 AM
Moral Hazard!?!? Moral Hazard? How DARE you conservatives talk to us about morals…you rightwingnut hypocrites…because…because…Bush tortured freedom fighters and lied and stuff.
/liberal off
Lily on January 15, 2010 at 10:57 AM
Wow! I thought all the money came from “Obama’s stash.” You mean it comes from taxpayers???
RBMN on January 15, 2010 at 10:58 AM
Ed, Thanks for posting this, but I think you’re preaching to the choir. This should be REQUIRED viewing of every liberal that posts comments like “it’s all Bush/Repub. fault for the last 8 years of financial ruin. Obama is just trying to clean up the mess.” My head wants to explode every time I read this! I want to cram this video down their throats.
http://www.youtube.com/watch?v=_MGT_cSi7Rs – Democrats, in their own words, sanctioning their own culture of corruption and complicity in the housing meltdown.
Fannie and Freddie jobs are nothing more than place holders for corrupt, out of work, politicians until they manage to gain back power. If there is one thing I hope conservatives do, once they regain office, is educate the public on what really caused this financial collapse and who the real culprits are. Palin may be a good advocate for this on Fox now. We need to ensure that this corruption gets huge exposure so that these monsters are never allowed in office again. If life was fair, they’d all be in jail with Madoff.
“One can usually tell what offenses against the commonweal the liberal Democrats are committing by what accusations they make against others (into which they project their own tendencies).” Culture of corruption indeed.
SoldiersMom on January 15, 2010 at 11:15 AM
There is probably something to that, but the author is way overstating its importance. You are talking about a minor trend in portfolio selection, and, while it cost people money in the crash, it didn’t cause it.
Count to 10 on January 15, 2010 at 11:17 AM
***
Good job Niki! Clear, concise, well presented by a nice looking lady. Keep up the good work. In 3 minutes the reasons for our recession are made quite clear.
***
John Bibb
***
rocketman on January 15, 2010 at 11:23 AM
I’ve never understood the thinking behind the notion that banks are racist and deny minorities loans. Are we really to believe that banks are more racist than they are greedy? If a bank thinks you can pay back a loan they will give you one. They want your money. They don’t see black or white – they see green and provide a useful product in the process.
gwelf on January 15, 2010 at 11:50 AM
In arrirmative Action Politics, there is no concern over what is passing or not passing.
It’s what makes you feel good that counts, no matter what the cost.
Badger40 on January 15, 2010 at 11:53 AM
Affirmative
Badger40 on January 15, 2010 at 11:54 AM
I imagine someone will still think this is a racist mentality.
What about Martians?
Badger40 on January 15, 2010 at 11:55 AM
It’s OK…
Obowma and Barney Frank will just print more money.
What could go wrong?
Seven Percent Solution on January 15, 2010 at 11:57 AM
Yes, time to go out and buy a wheelbarrow.
Chip on January 15, 2010 at 11:59 AM
He still has to take our guns away first. Without that, the danger of citizen uprising is too great. I don’t know how long he can count on the military to back a Cloward-Piven strategy. In the event of a revolution, I truly feel a significant portion of our military will sit this one out, if not join the revolution outright. Nothing to back this idea…it’s just a feeling.
SKYFOX on January 15, 2010 at 12:06 PM
There is probably something to that, but the author is way overstating its importance. You are talking about a minor trend in portfolio selection, and, while it cost people money in the crash, it didn’t cause it.
I’ve done the math, Count.
Do you know how much the market was overvalued by in January 2000? The number is — $12 trillion. That’s the amount of money that was going to disappear from the pockets of middle-class investors over the next few years in the event that stocks performed in the future anything at all as they always have in the past. Take $12 trillion of spending power away from the middle-class and you are going to see millions of failed retirements, millions of failed businesses, millions of failed marriages. It’s not a small thing.
From a market perspective, you are talking about trillions of dollars that were allocated in a way in which they would not have been allocated if the market had been permitted to function properly. People who thought they had far more in their portfolios than they in fact had spent money on houses and cars and vacations that they would not have spent had they known the accurate numbers. And businesses that were offering more frugal choices were driven out of business by a malfunctioning market, a market that would have been rewarding and punishing entirely different groups of businesses had there been a way for investors to obtain accurate information on how stock investing works.
Conservatives often complain that the conventional media is biased against them. I can tell you from personal experience that the bias re Buy-and-Hold is 10 time greater than anything seen in the political field. Discussion of the academic research described in that Google Knol has been banned at the followed places: (1) Motley Fool; (2) IndexUniverse.com; (3) Morningstar.com; (4) Bogleheads.org; and numerous big-name blogs. If there is not much to this, why the bans? Why would The Stock Selling Industry be so opposed to letting word of this get out if it were not a big deal?
Markets are great when they are able to function. When the people comprising a market are not able to obtain accurate information on the things they are buying in a market, that market collapses.Our economic system cannot survive the continued promotion of Buy-and-Hold. There are too many middle-class people invested in stocks today for a policy of permitting people to hear only one side of the story to continue.
Rob
Rob Bennett on January 15, 2010 at 12:14 PM
The FDIC is also now tasked with enforcing CRA and is hiring enforcers.
They get Econ 101, they just believe in socialism. Obama just dumped $100 million on LA to purchase homes because apparently the subprime loans and loan mods aren’t enough to keep people in homes they can’t afford. The are building their base while we worry about one race in Mass.
Free Government Housing!
PattyJ on January 15, 2010 at 12:41 PM
What’s this:
.
.
The Justice Department is searching for suspected cases of “reverse redlining.”
.
So, bottom line, th banks were supposed to lend to just about everyone.
.
.
But yesterday, Yahoo News posted this (still up):
.
“Obama tells banks: `We want our money back’”
.
Something’s up:
– ObamaCare looks like a failure (no one wants it, and Sen Ben Nelson’ inability to go out in public teatifies to that),
– C&T looks like a dead issue,
– Gitmo isn’t closing (and likely no one will be transferred to the US)
– I bet that the KSM trial is off (if BO can still get him out bcak to Gitmo)
– The NBPP stink has cost a job or two
– It looks like there’s going to be a Brown-out in Mass. (and probably much of the rest of the nation in 10 months)
.
Calling for bankers to pay is a good tactic, but probably not an end in itself.
.
What new governmental intervention is on the political horizon?
Arbalest on January 15, 2010 at 1:25 PM
Two points. Buying and selling stocks cost money.
Most individuals do not have time to research companies to the point where they can tell if an individual stock is over or under priced.
MarkTheGreat on January 15, 2010 at 2:25 PM
If you are really this good at determining what the true price of all stocks should be, why aren’t you filthy rich?
MarkTheGreat on January 15, 2010 at 2:28 PM
When somebody has to invoke a conspiracy theory that names every single major player, there’s a good chance you are dealing with a kook.
MarkTheGreat on January 15, 2010 at 2:32 PM
I knew a young man who had convinced himself that he had developed a system for winning a roulettes. He spent months perfecting this system, running simulation after simulation on his home computer, using a program he had written himself that was based on MicroSoft’s internal random number generator.
When he got up his courage and took $1000 dollars to the nearest casino, he quite quickly lost his entire stash.
Do you know why?
It was because he didn’t know enough math to understand the difference between random and pseudo-random.
MarkTheGreat on January 15, 2010 at 2:37 PM
Maybe he can be the first programmer to realistically simulate cheating and make a fortune selling his product to gamblers around the world.
Dark-Star on January 15, 2010 at 3:30 PM
How many in Congress can explain the concept of moral hazard much less see its application to the subprime meltdown?
If Congress did not see the subprime crisis coming, how is it that they can draft legislation to prevent a similar crisis?
Angry Dumbo on January 15, 2010 at 3:30 PM
Most individuals do not have time to research companies to the point where they can tell if an individual stock is over or under priced.
You’re confusing Indexing with Buy-and-Hold, Mark.
Indexing is wonderful, in my view. Indexing lets us tap into the benefits of stock investing without having to research the individual companies. This permits us to obtain huge diversification at little cost. What’s not to like?
Buy-and-Hold is something very different. Buy-and-Hold is the idea that you don’t need to adjust your stock allocation even when stocks are priced at insanely dangerous levels. This defies common sense. And the historical record shows that it is always ends up being a disaster for those who follow it (and for the entire society that permits heavy promotion of it without pointing out the dangers). The historical data is public information. You don’t need to take my word on this. The data is available on the internet.
Rob
Rob Bennett on January 16, 2010 at 9:34 AM
If you are really this good at determining what the true price of all stocks should be, why aren’t you filthy rich?
Do those who understand that it is a bad idea to drive drunk become filthy rich because they know this? They do not. But they usually end up better off than those who do not understand that it is a bad idea to drive drunk.
Buying stocks when they are selling at insanely dangerous prices is a bad idea. But there is no way to become filthy rich as a result of knowing this. Still, I would rather see my portfolio survive than see it destroyed in the economic crisis that inevitably follows a time in which Buy-and-Hold is heavily promoted by The Stock Selling Industry. There is not one case in the historical record in which Buy-and-Hold paid off for the long-term investor (and even The Stock Selling Industry is hurt in the economic crises caused by the heavy promotion of Buy-and-Hold).
Rob
Rob Bennett on January 16, 2010 at 9:38 AM
When somebody has to invoke a conspiracy theory that names every single major player, there’s a good chance you are dealing with a kook.
Or —
You might be dealing with someone who does not share the institutional interests held by those making millions promoting the for-a-time conventional view.
The New York Times and the Washington Post and CBS and ABC and NBC all thought Obama would make a great president, did they not? Did that make those who thought otherwise “kooks”? I say “no.”
This thread is about markets. I say that, for markets to work, there needs to be access to various points of view. When Morningstar or Motley Fool or any of these others bans honest posting on the flaws of Buy-and-Hold, the market ceases to function. The people who comprise the market no longer have access to the information they need to have access to to make the market work.
Those who advocate Buy-and-Hold argue that it is a free-market approach. They say that the market is setting the price and that therefore we can count on it being right. I don’t buy it. If honest posting were permitted, then, yes, I think the market would set the price properly. But this is a case where one industry has millions to spend promoting its Get Rich Quick scheme and the 10 percent of the population that possesses a better understanding of the realities has no effective means to get its message out.
I had a guy on a blog tell me a week or two ago that he had never before even heard Buy-and-Hold described as a Get Rich Quick scheme. That’s telling, in my view. What kind of market is it when only one side of the story can be presented? Markets are all about freedom. Even its strongest advocates do not believe that Buy-and-Hold can survive an open and reasoned discussion of its pros and cons. Otherwise, why would they support bans on honest posting?
Rob
Rob Bennett on January 16, 2010 at 9:47 AM
It was because he didn’t know enough math to understand the difference between random and pseudo-random.
I think you are putting forward a helpful caveat here, Mark.
No one of us knows it all. We need to have our views questioned so that we can find out if they survive informed scrutiny.
Maybe I am wrong. If I am I sure want to have people like you doing their best to identify the weak points in my arguments.
Do those who advocate Buy-and-Hold feel the same way? I think it is fair to say from my eight-year effort to find a place where honest posting on these questions will be permitted that they do not. That suggests to me that support for this “strategy” is emotional in nature. If the ideas could be defended, advocates of the idea would invite challenges. No?
Rob
Rob Bennett on January 16, 2010 at 9:52 AM