Recently Krugman argued that the extremely generous terms given to banks, while frustrating, are not a source of our current problems. Instead, the problem is that we stopped there. Basically, he’s arguing we should have bailed out Main Street too. Given that, I think it’s worth noting that the people behind the decision to stop using government money to help the economy and start tightening belts were the very people who most benefited from those early generous terms.
The story is almost exactly that of the ungrateful servant. Wealthy companies and individuals took incredible risks with borrowed money, lost more than they could account for, and were given forgiveness. But then rather than extending that aid down to their debtors they demanded harsher terms for them. The only element missing is the king to throw them in prison for their hypocrisy.
I think the most ironic element is the argument of moral hazard. It’s how people think money works, if you borrow more than you can pay back you need to be punished. We can’t let people get free money for making bad decisions.
The problem is, by and large, the people who are being held responsible for their actions are the least culpable. Certainly, some people acted in bad faith, but the majority acted on the advice of financial experts. The same financial experts who were forgiven their more intentional financial recklessness. And those same experts who are now championing the call for the government and middle class to bear the consequences of the debt they are left with.
Moral hazard can be a real danger, but it can also be an excuse. And we’ve gotten it exactly backwards. It’s a real danger in the financial and banking industries, where the risk of loss is the only thing preventing reckless and dangerous practices. And financial institutions can intentionally engineer the type of crisis that requires a government bailout. Individuals can’t do that. And we have the additional protection from moral hazard at the individual level that lenders have to be willing to lend to them. As long as the controls that keep the banks honest work, the banks will protect themselves from reckless individual borrowing.
Of course, most people agree that the bailouts were a problem. And many agree that we should have done something to help homeowners thrown upside down by the bubble bursting. But I think I’m suggesting that the general perception of why and how are backwards. It’s not that we shouldn’t have bailed out the financial sector, that was necessary. It’s that the rescue needed to come with a cost, primarily in the form of restoring much needed regulations. And on the flip side, we should have done more to insulate the middle and lower classes from the costs of the financial crisis, both for practical reasons and because they were, in general, more victim than instigator.