Treasury Department Denies Existence of Moral Hazard
After banks received billions of dollars when their risky investments failed, most economists understand that, without strict controls, markets and banks are going to continue to operate as though, if banks continue to fail because of risky investments, the government will continue to bail them out. That moral hazard, when added to the moral hazard engendered by lobbying, means the government has to take serious measures to convince both banks and the market that this last bailout was a one-time only thing.
But just saying that the government won’t bail out any further banks — which is exactly what the government said about Fannie Mae and Freddie Mac before it bailed them out — isn’t quite enough. Of course, a government assurance is all the hedge against moral hazard that the Treasury Department is currently prepared to offer. When asked about moral hazard by the Congressional Oversight Panel, Assistant Secretary of the Treasury for Financial Stability Herbert Allison said:
“There is no ‘too big to fail’ guarantee on the part of the U.S. government.”
The government doesn’t plan on bailing out every company it deems “too big to fail,” but Allison didn’t say it wouldn’t, either. Worse yet, Allison doesn’t guarantee anything about bailouts for companies that fall short of the “too big to fail” standard, either. With so little in the way of concrete assurances from the U.S. government that the bailout will never happen again, markets and banks will learn strictly from experience — and that experience is that, when push comes to shove, the government will ride to the rescue rather than face the political fallout from any failure.