Bernanke's renomination to the Fed: the mother of all moral hazards

[Peace4us]

Washington's favorite term these days is "moral hazard." Though this buzzphrase may seem like a complex and even intimidating idea, most of us, whether consciously or not, understand the principle because it's basic common sense.

Applaud your kid for punching another kid — rather than grounding him — and you've created a moral hazard that means he'll probably punch other kids in the future. Give your dog a treat — rather than a scolding — after he urinates in the house, and the moral hazard you've engineered makes it likely you'll soon be cleaning up even more sallow stains on your rug. In short, without consequences — or worse, with rewards — for wrongdoing, there is an incentive to do wrong. That's moral hazard.

To date, the national discussion about this concept has revolved specifically around financial moral hazard. And, as evidenced by trillions of dollars in public loans, guarantees and subsidies given to speculators to cover their massive losses, leaders in both political parties have no interest in preventing financial moral hazard — despite stern news releases insisting the contrary.

By rewarding rather than punishing Wall Street for losing irresponsibly risky bets and by holding out the promise of similar bailout rewards in the future, politicians have incentivized even more irresponsible risk-taking for years to come.

But financial moral hazard is only half the story. The other half is political moral hazard — the mother of all other moral hazards.

Consider, for instance, Federal Reserve Chairman Ben Bernanke. He's the top regulator who not only sowed financial moral hazard with the Fed's post-meltdown bailouts, but openly admits that as the crisis developed, his Federal Reserve "should have done more — we should have required more capital, more liquidity (and) we should have required tougher risk management controls."

Firing Bernanke would tell other regulators that there are consequences for negligence. Instead, President Obama rewarded Bernanke with renomination and thus manufactured a pernicious problem. As economist Dean Baker says, just as bailouts create a financial moral hazard giving speculators no incentive to avoid excessive risk, Bernanke's renomination creates a political moral hazard whereby regulators "will not have an incentive to do their jobs properly (because) there are no consequences" for failure.

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