Moral hazard, risk and wealth redistribution
Political class wealth redistribution (Part 9)
Federal Reserve Chair Janet Yellen recently expressed grave concerns about the “growing gap between the rich and everyone else…..” (Source: Martin Crutsinger Associated Press, Dayton Daily News, 10/18/2014). Crutsinger observes this is unplowed ground for a Fed Chair to talk about the meteoric rise in relative net worth for the super-rich. Yellen reports that from 1989 to 2013 the average net worth, adjusted for inflation, for those in the top 5 percent jumped from $3.8 million to $6.8 million. The irony here is that Ms. Yellen, Ben Bernanke who Yellen replaced, and the Federal Reserve Board, not to mention Congress who oversees the Fed, have been the prime enablers for the engine that “By some estimates (drove) income and wealth inequalities near their highest levels in the past one hundred years,” says Yellin.
Although “moral hazard” in the economic and behavioral sense has been around forever, we can go back to Michael Milken in the 80’s to identify a big winner who exploited moral hazard to the fullest. Moral hazard allows bad actors to make bad decisions without suffering negative consequences. In another example of our upside-down justice system, Milken was indicted for 98 counts of racketeering and fraud and finally pled guilty to six counts of securities fraud and tax evasion. (Source: Forbes.com, The world’s billionaires: #488, Michael Milken, Oct 10, 2010) Milken was sentenced to 10 years in prison, but served only 22 months. In 2010 his net worth was estimated at $2 billion. In his defense, Milken has given much of his wealth to charity, but even if he gave away 95 percent of his $2 billion, he’s still left with a cool $100 mil or so to maintain the lifestyle of the rich and famous. In any case, the bottom line here is that Milken risked and lost billions from private equity investors, escaped serious consequences with a “slap-on-the-wrist” plea bargain and came out the other side himself a billionaire.
Congress, and financial services and bank lobbyists are worse in the sense they push through laws that enable the Fed and other bad actors to make investments, risky and otherwise, that are insured by taxpayers who haven’t a clue they are being scammed. Private investors should have their eyes wide open before they entrust their wealth to the likes of Milken, but often the citizens only protection from the scam artists comes from oversight powers with their elected representatives. Unfortunately congress more often than not gives financial institutions a license to scam citizens as long as they disclose their dirty deeds in complicated, fine-print disclosures.
Whether or not you agree that fractional banking is good for the economy, it does provide an excellent opportunity for banks and other financial institutions to make high profits while transferring the risk to the taxpayer, another exquisite example of “moral hazard.” For starters, banks pay next to nothing in interest on savings and checking accounts, money market deposits and certificates of deposits. Moreover, those deposits are applied to the fractional reserve requirement which in the U.S. is about 10 percent. Let’s say a citizen deposits $1,000 in a savings account which earns $1 a year at the going rate of .001 percent interest. The bank can then lend 10 times that (determined by the 10 percent reserve requirement) at interest rates from 3-30 percent, earning $300 to $3000 in a year. Sure the citizens’ deposits are insured by the Federal Deposit Insurance Corporation (FDIC), but at the end of the day we pay the premiums on the insurance by paying 30 percent interest rates or more, and nickel and dime fees and penalties such as a $35 fee for paying off a credit card a day late.
Although some big bank bailouts after the Great Recession in 2008 actually made money for the Treasury, the fact remains the government coughed up $700 billion to rescue “too big to fail banks,” but also the super-rich who led us to the abyss in the first place.