Another weekend, another financial bailout. Will it be enough? Last week it was Washington Mutual, America’s largest Savings and Loan being packaged up for the government’s favourite financial holding company JPMorgan Chase. Last March the American government intervened to ensure the investment bank, Bear Stearns, was sold off to the same outfit. Who will it be next week? Which pillar of Hercules will come tumbling down signaling, once more, the end of the world as we know it?
On September 7th the government rescued the two largest mortgage insurers, known by the nicknames Fannie Mae (FNMA) and Freddie Mac (FHLMC). Many commentators worried that the March and September interventions created a “moral hazard”. This is an obscure term from the insurance industry that tries to predict how someone insured against a risk may act in such a way as to make the risky behaviour more likely. For example, some people think it is more likely that a house insured against fire is more likely to burn down than one not so insured. In this context, the lack of a mid-September government bailout for Lehman Brothers was said to be an object lesson for investors – the government will not insure you against your own reckless investments. In the light of the subsequent rescue of the insurance giant AIG, a better definition seems to be the privatization of profits and the socialization of losses.
In the Canadian context, there is a different kind of moral hazard at work. For many years now, the Canadian government has been encouraging people to contribute more to their personal Registered Retirement Savings Plans (RRSPs). In 2000 the contribution limits started to increase after years of fixed rates and even cuts in the mid 90s. In 2008 the RRSP limit is 18% of earned income to a maximum of $20,000. This increase typically means an increase in investments in the stock market. Since the percentage of working Canadians with company pension plans has decreased over the last 10 years, this means the federal government is encouraging Canadians to rely on their own private investments to secure their retirement.
Canadians clearly are prepared to do that since approximately 50% of Canadians who file income tax also invest in RRSPs. But Canadians also expect that these government sanctioned and supported investment vehicles are properly regulated to ensure their interests are protected. To the extent that Canadian banks and investment houses have participated in sub-prime and higher risk mortgage pools from an insufficiently regulated American housing market, it appears that these institutions have behaved with less attention to risk than their fiduciary responsibility warranted. Did they believe the American government would bail them out? Do they believe the Canadian government will bail them out? Are Canadian financial institutions exhibiting signs of morally hazardous behaviour? I think they are.
Moral hazard is not just a matter of outright dishonesty. (Extreme versions of it are called fraud.) According to the Insurance Institute of Canada, moral hazard is more likely a consequence of carelessness and poor management. In a political climate where de-regulation and self-regulation is the flavour de jour (see the food inspection industry), Canadians properly expect their government representatives to ensure they are not exposed to the excesses of the cowboy capitalism they see to the south. Government encouragement of private investment to secure the common good of stable and dependable retirements, implies an obligation on the government to ensure those investment markets and managers are not reckless.
However, there is also something going on bigger than issues of moral hazard. The financial crisis is being described as a crisis in the American housing market caused by imprudent lending to homeowners. This is true as far as it goes, but it doesn’t go far enough. The sub-prime mortgage crisis is just the presenting issue. Any number of events could have precipitated this crisis. Rather, the crisis reveals the extent of and risks in the globalization of deregulated financial markets, and it could be worse.
The German government has rescued three banks in the last year because of American mortgages. However, they probably wouldn’t be able to rescue Deutsche Bank, which is so large it has liabilities the equivalent of 80% of Germany’s Gross Domestic Product. The British Government has now rescued two banks, Northern Rock and HBOS, because of their exposure to this debt. They probably wouldn’t be able to rescue Barclay’s Bank, the buyer of Lehman Brothers assets, whose liabilities are greater than Britain’s entire GDP. The largest insurance company in the world, AIG, has needed rescue because it has been selling insurance against this kind of default. The American government has been forced to act not only because it is an election year, but also because they need to satisfy Japanese and Chinese lenders. Foreigners hold 45% of the debt issued by the US Treasury with the largest investors being Japan (13%) and China (10%). If those countries start moving their money into Europe instead, the American dollar would fall rapidly - just as rapidly as interest rates would rise.
So, the world’s financial markets have expanded and integrated. But there has been no corresponding expansion and integration of regulation. Instead, the dominant voice of the last 20 years has been one of de-regulation. In consequence the livelihood of the whole modern world is now at stake.
In the 17th century, Isaac Newton proposed three laws of motion. His third law states that “for every action, there is an equal and opposite reaction.” In the 20th century, the economic historian Karl Polanyi proposed a similar kind of law. He said when market forces under capitalism expand, they are met by a countermovement aiming at the conservation of society, nature and production, using protective legislation and other instruments of intervention. This double movement in the 19th century he called the Great Transformation. It was how modern industrial society was born, complete with trade unions, pension plans, social housing, and healthcare.
We now desperately need another Great Transformation and if we’re lucky, we may be at it’s beginning. It is timely, then, to ask: by what values will this intervention be guided? Let me suggest four.
Matthew’s Gospel (7:26) reminds us to build our houses on a solid foundation, not on sand. That means our financial systems, like our ecological systems, have to be sustainable.
In order for the system to be sustainable, we have to be clear about what is sufficient for our common life. So far we have organized our affairs to achieve the maximum growth possible. What would “enough” look like?
Most people want some basic standards of fairness applied to income and employment, hence the desire to limit CEO pay for companies receiving public financial aid. This is the principle of equity.
Finally, ordinary people are wondering why all the government money is going to rescue private investors when ordinary homeowners are under water. They are looking for some collective support. They are looking for solidarity.
We’ve had enough of moral hazards. It’s time we had a moral economy.
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