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Beacon-omics 101: Is this fair? The 'moral hazard' of bailouts

This article first appeared in the St. Louis Beacon, Feb. 8, 2009 - Sure, we all know that life isn't fair, but American taxpayers are discovering that life during a recession may be the unfairest time of all.

  • Is it fair, for example, that the government is giving billions of tax dollars to assist lenders but not the 46,000 U.S. homeowners who every week join the ranks of Americans facing foreclosure?
  • Is it fair for executives of corporations that took bailout funds to get millions of dollars in bonuses, even as 598,000 Americans lost their jobs in January and unemployment has risen to 7.6 percent?
  • Is it fair to homeowners who lived within their means and met their financial obligations to watch their property values decline because their neighbors bit off more than they could chew and were foreclosed on?

"I don't like to bail out people who are consistently making mistakes,'' said Kathleen Petersen, 52, of Richmond Heights, who speaks for many when she said she would urge President Barack Obama to make decisions that help the "little people."
"As long as the decisions you're making come all the way down to us in a fair way, make those decisions,'' Petersen said. "I really need the government to watch out for people who aren't doing that. I have to pay attention to my life. I need you as president to watch out for Big Business who's not watching out for me. If you're going to bail people out, I don't want you to loan money to people who are irresponsible.''

Petersen said she supports Obama's attempts at attaching boundaries to taxpayer-funded bailouts, such as a $500,000 cap on the salaries of executives of companies that accept rescues funded by U.S. taxpayers.

"You don't get a bonus if you're failing. I know I wouldn't get a pay raise; I shouldn't get a bonus if I screwed up that much," she said.

When Congress is finished quibbling over Obama's economic stimulus package, the final cost will still approach $1 trillion. Add that staggering number to the $700 billion in the Troubled Assets Relief Program already being doled out to the nation's financial institutions - and an additional bailout for financial institutions expected to be announced Tuesday, price tag as yet undetermined.

At the same time, critics say, little has been done to address the heart of the economic crisis - the continued failure of millions of so-called "toxic" mortgages that were bought and sold and divvied up into complicated financial investment instruments that have spread throughout the global economy, nudging Wall Street and the world's financial markets over the cliff.

Petersen, a psychologist in private practice, said she and her husband have faced their share of debt - student loans, car payments, credit card debt and a home mortgage - and they found a way to pay it.

"No one bailed me out,'' Petersen said. "And I didn't expect anyone to bail me out."

She said she has tried to instill in her daughters, ages 16 and 19, a sense of personal responsibility when it comes to finances. She points out that her parents were children during the Great Depression, and she learned from their experiences.

"How did you fix things then? You worked harder. You pulled together with family," Petersen said. "You tighten up. You save instead of spend."

Petersen believes the nation's financial institutions have been given enough help, and it's time for them to use those funds to help fix the economy. Why, she asks, are credit card companies charging borrowers 28 percent interest, while her savings account is paying less than 1 percent in interest?

On the other hand, Petersen supports federal aid for states that need help to assist the growing numbers of the unemployed.

"That's really important to do because that's feeding people, and I think we've got to be able to help states take care of the people. We don't want children suffering," Petersen said. "But sometimes people have to suffer in order to learn."

The dilemma, Petersen acknowledges, is finding the right balance in providing help to those who need it - while not rewarding people for bad behavior.

The moral hazard of bailouts

Economists have a term that covers Petersen's concerns over rewarding irresponsible financial behavior. By definition, "moral hazard" refers to the lack of incentive to guard against risk by someone who has been protected from the consequences. That protection might be provided by an insurance policy, but it could also be provided by a bailout.

As Robert Cropf, an associate professor of public policy studies at St. Louis University, explains it, "Anytime there's a bailout or a planned subsidy of some sort of activity by the government, there's always the danger of unfairness to certain people - in this case those who played by the rules, did things the right way, did not get over-leveraged in terms of debt. Or, who did not take overly risky chances with yours or someone else's money.''

But, Cropf adds, the pertinent question is: What's the larger good?

Clearly, there is much blame to pass around for the current state of the economy, he said.

"We don't want to reward those people, but, on the other hand, we're watching as the economy slides more and more into ruin every day in large part because of these toxic investments and loans,'' Cropf said.

"And if we don't do anything, I think it's very clear that we're looking at a 21st-century version of the Great Depression. I might not have said that six months ago, but the signs are very clear. The writing is on the wall. Job loss is no longer something that is unusual and rare. It happens every day and in numbers that are in the thousands. There is a very real risk of a cycle of deflation.''

Capitalism's 'haves' and 'have-nots'

While Americans are asking all sorts of questions about fairness these days, the reality is that those concerns always exist in a capitalist society, political scientists say.

"Let's get to the bottom line about the capitalist system that we embrace. Automatically, there are going to be some people who are winners and some people who are losers," Cropf said.

He adds that those people aren't necessarily losers because they did anything wrong or weren't smart.

"For whatever reason, they may have made poor investments. And maybe someone who was not as smart as they are -- or as committed or as hard working -- made good investments. Is that fair? No, it's not, but that's the capitalist system," Cropf said. "We have to expect a certain amount of unfairness when we talk about capitalism. Is it unfair for someone to go out and buy a lottery ticket and not work a day in their life and win $14 million?"

Andrew Rehfeld, an associate professor of political science at Washington University who has researched fairness and ethics in American government, said the gulf between the "haves" and "have-nots" has been growing since the 1980s.

"And the first question is, why wasn't there outrage then and why weren't there concerns of fairness then, at least in the popular media?" Rehfeld said.

The answer, he believes, is the long-standing belief that opportunity would allow those in the lower class to rise up to the upper class -- even though research has shown that there was not as much economic class mobility as people thought.

"The belief was that as long as you worked hard, the opportunity was there. Now, in this time of economic crisis, there is a greater awareness that there isn't going to be that opportunity," Rehfeld said.

Add to that rude awakening the behavior of some "haves" - the corporation executives who continued to take excessive bonuses and salaries, even while laying off employees, he said.

Who should get what?

Petersen recalls watching a cable television show about "house flippers" who were making quick money by buying and reselling homes. She believes the greedy deserve whatever they got when the housing market went south - as do people who were careless in their choices.

"I think there are people who make stupid decisions and don't understand that they need to live with the consequences. Sometimes it just happens,'' she said.

Petersen believes that consumers need to read the fine print and shouldn't expect to be rescued when they get into trouble. At the same time, she says, lenders should bear their share of the financial loss.

"It's got to be a balance between the people who gave the loan and the people who took the loan," she said.

But while assessing blame and responsibility on a case-by-case basis would be the fairest thing to do, it would be costly, time-consuming and nearly impossible, Rehfeld points out.

The government has to choose a method for distributing a limited amount of assistance: Either give everyone an equal share or concentrate the money where you think it will do the most good, he said. The bottom line is that some people will be overpaid while others are underpaid.

"I don't think it's helpful to think about the spending necessarily in terms of fairness, though that's what people tend to do," he said. "How do you distinguish between the people whose failed mortgages are their own fault or who got suckered into a bad mortgage? Or, the economy went south and they can't pay. That's really hard to do."

Rehfeld said that no matter what plan is devised, it will be crude in the sense that it can't take into account the specifics of every individual case - as much as taxpayers might like to see that.

"If we stop and wait until we have a precise measurement, you wouldn't have a policy in place for five years, and you wouldn't want that," he said.

Also difficult is the assignment of moral blame to the villains.

"There are some clear villains - the people who willingly jacked up the evaluations of the homes, or who knew that was happening and let it stand, or knew the borrower couldn't possibly make the payments. Also, the individual borrowers who did not do diligence,'' Rehfeld said.

Rehfeld agrees that consequences are important.

"If you don't create penalties and you don't create consequences for bad behavior you provide no disincentive for it to happen again,'' he said.

In the end, Cropf said, the recession is worsening and the nation must take action.

"If we drag this thing out because of some ideological or moral position, and if we don't reach some sort of practical solution as a society - then it might be our housing values and our jobs that are lost,'' he said.

Cropf isn't sold completely on Obama's plan because he believes there should be more emphasis on immediate stimulus and he thinks Congress has added too much pork. He also believes that a healthy debate is warranted.

"But can we dawdle for another six weeks?" he asks. "No.''

Fear together

American history reminds us that the nation has faced economic troubles before that were rooted in greed: the infamous gold scandal of 1869, and, yes, the Great Depression.

"There has always been a strong tendency in America to want to be able to speculate,'' said Wayne Fields, a Washington University English professor who studies American rhetoric. "And in a sense, what allows that process to take place is the ability to make it seem like it can be extended everywhere; we can all have a piece of that action. We can all come out on top.''

Fields says Americans are feeling angry and betrayed these days because they feel suckered.

"There were a lot of people doing dumb things for what they thought were smart reasons - encouraged by people whose class they were eager to join,'' he said.

For Fields, the 1933 inaugural speech of President Franklin D. Roosevelt is most meaningful not for its most memorable line - "the only thing we have to fear is fear itself'' - but for these words: "In such a spirit on my part and on yours we face our common difficulties. They concern, thank God, only material things."

Fields believes that wealth had become synonymous with the nation's cultural sense of worth - and watching the stock market had become a national obsession. Our worth was not related to our own labor but to what someone else was doing with our money.

"We lost the American Dream, in one sense, when we decided it was about gambling. The American Dream was, at its core, a commitment to the meaning and value of work. When you advertise the lottery - you win this and you don't have to work - you undermine a sense of purpose and direction,'' Fields said.

Ultimately, people have lost faith and confidence, not only in Wall Street, but in one another, he said.

"I think the biggest challenge Roosevelt faced was to keep any semblance of a united people,'' he said. "We have to rebuild a society in which we at least imagine that most of us want to take care of one another and not just ourselves. That's easier to do in a time of crisis and want than it is during a time of plenty.''

Fields said people had come to see the stock market as a way to take an investment and enlarge it, without worrying about risk.

"The reality is that whether it's a pyramid scheme, or the market or an inflated notion of what our house is worth, that there is a day of reckoning. We hit that, and we were psychologically unprepared for it,'' he said.


Moral hazard: The risk that a party to a transaction has not entered into the contract in good faith, has provided misleading information about its assets, liabilities or credit capacity, or has an incentive to take unusual risks in a desperate attempt to earn a profit before the contract settles.  Source: www.investopedia.com

Mary Delach Leonard is a veteran journalist who joined the St. Louis Beacon staff in April 2008 after a 17-year career at the St. Louis Post-Dispatch, where she was a reporter and an editor in the features section. Her work has been cited for awards by the Missouri Associated Press Managing Editors, the Missouri Press Association and the Illinois Press Association. In 2010, the Bar Association of Metropolitan St. Louis honored her with a Spirit of Justice Award in recognition of her work on the housing crisis. Leonard began her newspaper career at the Belleville News-Democrat after earning a degree in mass communications from Southern Illinois University-Edwardsville, where she now serves as an adjunct faculty member. She is partial to pomeranians and Cardinals.

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