Frustrated with Tiger Woods banality on the major networks last night, I switched on PBS and caught a segment on the Lehrer News Hour with George Schultz discussing his belief that the financial crisis was due to the government creating a moral hazard with it’s ‘too big to fail’ bail-out nonsense. He asks, if they’re too big to fail, why not make them smaller? Great question.
I highly recommend watching the video. Click here and it should be the first video listed on the left of the screen.
I nearly fell out of my chair. Finally, some reason in media. Good job Lehrer. Getting warmer.
Moral hazard is the unintuitive lingo economists use to describe the idea that if someone or something is there to bail you out, you do things differently than you would if you didn’t have that backup.
If somebody knows they’ll be bailed out, they take excessive risks because they do it [take risks] on the taxpayers dollar. The whole system is badly damaged when bailouts occur because it takes accountability out of the system and the market system depends on accountability, so we have to design a system so that anybody in it can fail.
The interviewer, who I hope was playing dumb for his audience (I think he was), asks Shultz if this is something he’s seen in the past or “is this a new phenomenon?” This isn’t new.
This is everyday human behavior that’s been around since the dawn of mankind. If someone tells you they’ll pay for your retirement, you don’t save as much. If you parents got you out of trouble when you were a kid, you got into more trouble.
Schultz explained two examples from the past to illustrate moral hazard.
First was a strike the longshoreman in 1968. President Johnson enjoined the strike to prevent national emergency. When Nixon took office and Schultz became his Secretary of Labor, another strike fired up, why not? The President is going to help them get what we want to avoid a national emergency.
Schultz said Johnson was wrong and Nixon should stay out of it. It would teach them “they have to take responsibility for their own actions,” kind of like the parent who finally learns they aren’t helping matters by soothing the temporary pain for the child who made a bad decision. Nixon listened and the strikes died down.
Another example was with the failure Penn Central railroad. The railroad grossly managed their affairs. The Federal Reserve Chairman, Arthur Burns, wanted to give Penn Central a bailout to prevent a massive failure of the financial system. Sound familiar?
In the end, he didn’t bail them out because they had retained Burns’ former law firm and a bailout would look too suspicious. Penn Central failed. There was no ripple effect. The economy kept chugging.
While Schultz said a lot of good things in the interview, that wasn’t the part that fascinated me. What fascinated me was that there was no yelling. He wasn’t chastised for challenging today’s conventional wisdom that markets failed. He was allowed to state his case and rationale in a calm manner and the interviewer tried to understand his points, rather than stuff him in the face with populist lay-ups.
I could imagine Matt Lauer conducting the same interview. When Schultz said that staying out of the strikes would teach them they they need to take responsibility for their actions, I could envision Lauer cutting him off and asking him in his condescending tone something like, “but don’t you think the longshoremen need the muscle of the government behind them, because the companies have all the bargaining power?” Or, “shouldn’t we have bailed out Penn Central? X thousands lost their jobs.”
Then Lauer wouldn’t have given Schutlz a chance to explain that the end result of the actions that weren’t taken were far away better than what would have happened after the temporary soothing of the government action, much like the parent who finally decides its time for their kids to learn a lesson.