Fed Treads Moral Hazard
Step In and Cut Rates
Or Stand By and Watch:
Whither Helicopter Ben?
By E.S. BROWNING
August 13, 2007; Page C1
Wall Street has a dream: that the Federal Reserve will rescue
financial markets with a sharp cut in interest rates.
Behind that dream lurks a problem, something financial people call
Moral hazard is an old economic concept with its roots in the
insurance business. The idea goes like this: If you protect someone
too well against an unwanted outcome, that person may behave
recklessly. Someone who buys extensive liability insurance for his car
may drive too fast because he feels financially protected.
These days, investors and economists use the term to refer to the
market's longing for Federal Reserve interest-rate cuts. If investors
believe the Fed will rescue them from their excesses, people will take
greater risks and, ultimately, suffer greater consequences. Some
grumble that the Fed created problems this way in 1998, 1999 and 2003.
If the Fed were to cut rates now, it certainly could help with the
current market crisis. The cheaper money would reduce pressure on
stock and bond markets by making it easier to buy beaten-down stocks,
bonds and other securities world-wide. Wall Street is a powerful lobby
in Washington, and its bleating for help can be hard to resist for
politicians, whose campaigns often depend on financial contributions
from Wall Street figures.
But if the Fed were to ride to the rescue, the skeptics worry, it
would encourage people to speculate even more, creating an even bigger
"You don't want to see the Fed bail out these guys who have made a lot
of money. They have made their bed and you want to see them lie in
it," says a veteran trader at a New York brokerage house. "Then again,
you don't want to see the economy go into recession."
That, in a nutshell, is the choice the Fed's policy makers face today.
Earlier in his term as Fed chairman, Ben Bernanke was seen by a lot of
investors as possibly too inclined to bail people out. Mr. Bernanke
was dubbed "Helicopter Ben" because of a reference he once made to an
economic theory that, if deflation threatens, the Fed's role is to
dump money into the economy as if dropping it from a helicopter.
Mr. Bernanke wasn't advocating such a posture, and many felt the
nickname was unfair. It has taken him months of steady insistence that
he wasn't about to cut rates and fuel inflation for the gadflies to
stop calling him that.
Now, it is the other side that is upset, worrying that his refusal to
cut rates will hurt growth and enable the credit crisis to fester.
Last week, Fed policy makers issued a statement reiterating their
determination to fight inflation, and the worriers grumbled the Fed
was being too tough.
But Mr. Bernanke's old critics -- those who formerly called him
Helicopter Ben -- cheered. Articles were written announcing that the
"Bernanke put" was dead. The "Bernanke put" was another arcane
reference, in this case to an option known as a put option that
permits investors to sell stock at a preset price, limiting potential
losses. Critics had complained that, as long as people could count on
the Fed to intervene in case of trouble, Mr. Bernanke was putting a
floor under the market -- offering a put. In earlier years, people
called it the "Greenspan put," a reference to then-Fed Chairman Alan
With people screaming from both sides, the Fed's response has been to
seek out the middle ground. Instead of cutting rates, the Fed has
offered additional loans to banks, to ensure there is plenty of money
in the financial system, and it has offered to buy bonds from banks
that feel they are holding too many bonds in the midst of a bond
Economists generally feel the proper solution to such problems is to
start small and use the least intervention possible. The Fed seems to
be saying that, if it can right the ship without cutting rates, it
will do so, and it won't cut rates unless things get worse.
Debates of this sort, featuring quaint expressions such as moral
hazard, have gone on for decades, and they flare up whenever crises
do. Some of the issues date back to the government's failed efforts to
save the economy from the Great Depression, a subject on which Mr.
Bernanke has written extensively. Some go back even farther.
Some still complain that the Fed, then led by Mr. Greenspan,
contributed to the stock bubble of the late 1990s. In 1998, the Fed
cut interest rates to support the bond market after it was swamped by
a Russian debt default and the near-collapse of a huge hedge fund that
specialized in bonds, Long-Term Capital Management. The Fed also
encouraged banks to rescue that hedge fund. Stocks, the riskiest of
which were down more than 20% at that point, quickly recovered.
Late in 1999, the Fed slowed its campaign of rate increases and used
other means to pump money into the system to avoid trouble as bank
computers switched to 2000 from 1999. That dose of easy money may have
helped prolong a stock surge that didn't end until early 2000.
Starting in January 2001, the Fed gradually cut its target rate for
overnight bank lending to 1% in 2003 from 6.5% in 2000. That kept the
economy out of a deep recession, but some complain that the Fed kept
rates too low for too long, laying the groundwork for today's
troubles, which were fueled by cheap money. The Fed began raising
rates at the end of June 2004, and the target rate today is 5.25%.
The complaint that the Fed was too slow to raise rates "leaves me
scratching my head: There is simply no hard evidence to support it,"
wrote Mark Gertler, an economics professor at New York University who
has co-written several academic papers with Mr. Bernanke, and who
submitted this comment to The Wall Street Journal's Real Time
Economics blog. "By keeping interest rates low in the absence of
inflationary pressures, the Fed prudently insured against a Japan-
style stagnation," Mr. Gertler wrote.
Just to show how hard it is to please critics, some complain the Fed
has been too tough -- not too lenient. They say the Fed raised rates
too much in the early 1990s, causing bond prices to collapse, and
again in 2000, throwing the economy into recession -- and should have
been cutting them months ago to prevent recession today.
In general, Fed officials say, they intervene to support the economy
and the financial system, not to bail out foolish investors.
Unfortunately, one can lead to the other.
An example: If your neighbor smokes in bed, you may hope he burns his
hand and learns a lesson. But if his house is burning down due to his
careless smoking, you probably would prefer that the fire department
come to extinguish the fire. In this example, the fire department can
send the careless homeowner a bill. In financial markets, that is
harder to do.
--Greg Ip contributed to this article.
Write to E.S. Browning at jim.br...@wsj.com
Obviously, the system isn't very well structured to
stabilize the market and protect the individual owners as
much as it is to protect the larger institutions.
which begs the question, is this morally right and ethical.
If yes to the above, we need to stop kidding ourselves about
the market and their effects and provide full disclosure to
also we may have to look at a radical solution to these bailouts.
what if we sue under some sort of equal protection type of thing.
after all, its our money that is now bailing out the rich for the
forth time since 1987. what about a bailout for us little guys?
i am sure a clever liberal lawyer could come up with a attack on this
aristocracy that will bypass our bought legislators.
Possibly, but can you also get past the bought jurist?
This is kind of situation the just confirms the position of
those that think the Fed.Res. is illegal and an element of
the fascist takeover of the economy. I'm not in that camp,
but there are some obvious problems.
Did you see that full text link I posted?
It's the same old problem in politics, some said it's for
the greater good and We'll fix the problems latter - But
they never did, and there is a reason for that.
In that sense our representative have not simply been
co-opted, they are actual co-conspirators against the public
interest, and are derelict in their oath and
responsibilities. OMG, could that be true?
yes it could, and I might add that if it is treason then
they should be charged and punished (and I'm beginning to
like the old world idea of punishment as a musket shot sur
American Conservatives on Healthcare-Too stupid to run a
system every other Western nation has figured out....
"Our privileged class is fine, and so why should we care
about anybody else."
"Begging the question" is probably the right phrase,
even if it isn't what you meant. The question probably
is, "is the market structured to protect anyone, and
should it?" Most market protections are to prevent
people from doing things for the wrong reasons.
Many of them are merely aimed at making sure
that people are fully informed prior to making
moves in the market. But there are also some
of them in place to address panic, or in
some cases, "irrational exhuberance". But if we accept
these kinds of protections for the large institutions,
and organized investors, where are such protections
for the individual investor? Why do we "allow"
zero equity loans for virtually anyone that wants one?
Frankly, I think if Bears or Morgan falls on their face, so
be - that's what market do if you mess up that badly.
To a very great degree I've often thought that this is THE
problem in so many ways, distance between authority and
action. The "out of control" CEO salaries and the stacked
boards which support them happen because of the distance
between the share holder and the running of the company.
With these marginal loans, I think it can be directly traced
to the fact that they were packaged and sold by people
who knew they would not be holding the risk. Add
to this a system in which people think they can always
"sell off" a risk that starts to go bad and you end up with
a game of musical chairs where everybody is assuming
there will always be one chair left.
I pretty much have to agree.
Any number of poorly rationalized position puts the
prospects for returns at risk. Successive rounds of sharing
or selling of the risk don't combat the problem at it's core.
what they really are doing, and they do not understand this. is that
they are rearranging the deck chairs on the titanic. a short term
solution to a long term problem.