Esoteric Dissertations from a One-Track Mind

August 18, 2007

The Liquidity Crisis and Moral Hazard

Filed under: capitalism, economy, politics — codesmithy @ 8:50 am

As one may have heard, the Federal Reserve approved the cut in the discount loan rate which caused a rally in the stock market. A detailed analysis of what is going on is given here. Basically, the Fed bought some time for hedge funds to silently or not so silently reposition their investments. This “bail out” is being paid for by future inflation by everyone. It doesn’t change the inevitable conclusion that the market will go bear. This is because value in the market takes into account expected values of future gains, and simply put, the future value doesn’t exist. That future value is based on the amount of debt people owe. The value of these sub-prime mortgages was the expectation of payments when rates go up, however given people’s meager ability to make ends-meet now, stagnant wages in conjunction with health-care, oil, energy and food cost increases makes the overall situation for people to meet all their liabilities worse.

The U.S. economy does face a moral hazard. I don’t believe that moral hazard exists in health care, however I do believe it exists in financials like this “liquidity crisis” and like the Enron implosion. Corporations and the wealthy are driven by an irrational exuberance to make more money. They fuel the booms and busts that the economy has experienced, with what can be called “the greater sucker theory.” The moral hazard comes from the fact when “a greater sucker” doesn’t come along, or when the “sucker” that you found is not able to meets his/her obligations the whole thing crashes. The fact that the elites go whining to the government every time they get caught holding the bag won’t ensure it doesn’t happen again. I’m sick of the government’s “deregulate and bail out” strategy. Either regulate the market to ensure the irrational exuberance doesn’t occur, so we don’t have to spend a lot of money bailing them out later, or deregulate and let the market boom and bust. The “deregulate and bail out” strategy effectively steals from the poor and gives to the rich.

The more frustrating aspect is the blatant hypocrisy of it all. Welfare and social safety nets are all frowned upon, but when the rich need help it is a dire problem that immediately needs to be addressed. I don’t want the economy to dive, but I also realize that bailing out a few well-off people at the expense of everyone else is absurd and especially unfair to people who are struggling. We have a perverse form of socialism for the rich, and capitalism for the poor. However, it is hardly a new phenomenon. To give some perspective, consider the following from “A People’s History of the United States of America: 1492-Present” by Howard Zinn (pg. 259).

In 1887, with a huge surplus in the treasury, Cleveland vetoed a bill appropriating $100,000 to give relief to Texas farmers to help them buy seed grain during a drought. He said: “Federal aid in such cases … encourages the expectation of paternal care on the part of the government and weakens the sturdiness of our national character.” But that same year, Cleveland used his gold surplus to pay off wealthy bondholders at $28 above the $100 value of each bond — a gift of $45 million.

Is this the result of a functioning democracy?


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