Magazine article American Banker

Moral Hazard, or Why We Need Regulation

Magazine article American Banker

Moral Hazard, or Why We Need Regulation

Article excerpt

At my class reunion at Brown a few years ago I was asked to participate in an ethics panel. I started out with a joke, of course.

"Daddy, what are ethics?"

"Well, son, let me give you an example. Let's say someone comes into our store, spends $20, and by accident gives me two $20 bills stuck together.

"The question of ethics is: Should I tell my partner?"

But then I got serious and took the theme "Thou shalt not tempt."

In the National League, pitchers must take their turn at bat. In the American League they are replaced by designated hitters. American League pitchers therefore have more incentive to throw beanballs, because National League pitchers know that today's beaner may well be tomorrow's beanee.

The designated-hitter rule is an example of what economists call moral hazard -- an invitation to act selfishly with no fear of risk to yourself.

The best example in the banking business, I told the Brown audience, is the savings and loan debacle. S&L operators knew that if they made risky loans that failed, the nation's taxpayers would pay -- as they did, to the tune of $2,500 per man, woman, and child.

I next reminded the audience of the outrageous salaries and bonuses that many corporate leaders have received. How do they get these rewards, completely out of line with what the rest of us make?

Moral hazard; there was no one to stop them. Most boards of directors are made up of full-time employees, friends and business associates of the CEO, and celebrities. All three lack the will to oppose the CEO.

Insiders fear for their jobs and promotion possibilities. …

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