The Moral Hazard Economy

Appetites for risk should naturally abate after the catastrophic losses we’ve just seen. Will too-rich bailouts prevent that from happening?

by

Peter L. Bernstein

by

Peter L. Bernstein

From the Magazine (July–August 2009)

Summary.

Reprint: R0907M

The Obama administration and the U.S. Federal Reserve—along with counterparts around the world—are doing their utmost to thaw the credit freeze that took hold in the fall of 2008. But these measures, says the author, serve to show how badly the housing and derivatives bubbles deformed the economy and the global financial system.

The first effect of the bailouts will be a dramatic rise in the size and cost of government borrowing, which will have serious inflationary consequences. Just as important is the transformation of the U.S. central bank into a version of the “bad bank” touted as a solution to the crisis. How disastrous the consequences will be depends on whether our appetite for risk has been increased by the bailouts or reduced by the meltdown.

The Obama administration and the Federal Reserve authorities—along with their counterparts around the world—are doing their utmost to thaw the terrible credit freeze that took hold in the fall of 2008. What could be guaranteed has been guaranteed. What trash the central banks could absorb has been absorbed. And the U.S. government has poured billions of taxpayer dollars of new capital into the country’s largest financial institutions. Other key industries are taking their place in the queue as well.

A version of this article appeared in the July–August 2009 issue of Harvard Business Review.

PB

Peter L. Bernstein, who died in June 2009, was the president of Peter L. Bernstein, Inc., an economic services consultancy. He was the author of 10 books on economics and finance, including Against the Gods: The Remarkable Story of Risk (John Wiley & Sons, 1996).

The Moral Hazard Economy

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