Inevitable Catastrophe: The Fruits of Moral Hazard on a Global Scale

06-24-2011 • OfTwoMinds.com/blog

Insulate participants from risk with policies like the Bernanke Put and you guarantee destruction of both the market and institutional legitimacy. Identify the common characteristic of these three statements: 1. The Federal Reserve will never let the stock market decline, i.e. the "Bernanke put" 2. The Chinese government will never let property prices decline 3. The European Central Bank will never let Greece default The answer of course is moral hazard: a person who is insulated from risk will have an insatiable appetite for risky bets because any gains will be theirs to keep but any losses will be covered by the central bank or government. The global financial authorities’ success in propping up assets (stocks in the U.S., real estate in China, banks in Europe, etc.) over the past three years has strengthened this asymmetric disregard for systemic risk into a dangerously quasi-religious faith that central banks and governments have essentially unlimited power to keep asset prices aloft via printing money, manipulation of markets and financialization of their economies. What happens if markets crumble despite massive, sustained central bank and government intervention? The institutions that created moral hazard will be revealed as false gods, and that faith will be destroyed.