Sorry for the formatting...
M
---------- Forwarded message ----------
Date: Tue, 29 Sep 1998 18:19:23 -0400 (EDT)
From: Robert Weissman <[EMAIL PROTECTED]>
To: Multiple recipients of list STOP-IMF <[EMAIL PROTECTED]>
Subject: WP, Glassman,"Reckless Bailouts" (fwd)
Reckless Bailouts
By James K. Glassman
Tuesday, September 29, 1998; Page A17
The principle behind welfare reform was simple: If you
pay people when
they don't work, then they don't have an incentive to
get a job. The
1996 law cut them off, and since then, millions have
left the public dole.
Economists call the principle behind welfare reform
"moral hazard."
When people are insured, or protected against the
consequences of
destructive actions, they are more likely to take
those destructive actions.
Thus, if able-bodied welfare mothers know they'll get
monthly checks,
they're less likely to work.
But in America today, there's a double standard. A
rule that applies to
welfare mothers doesn't apply to politically connected
corporations, rich
speculators and irresponsible nations. Over and over,
when powerful
people and institutions get into trouble, the
government bails them out.
The latest example is a Greenwich, Conn., hedge fund
called
Long-Term Capital, Ltd. (LTC), which was founded by
John Meriwether,
a "master of the universe" at Salomon Brothers, along
with two Nobel
Prize winners, a former Federal Reserve vice chairman
and other
partners whom Business Week called the "dream team."
Using as much as $100 billion in borrowed money,
Long-Term Capital
made some disastrously stupid investments and teetered
last week on
the brink of failure.
What should happen to a firm that makes terrible bets
on esoteric
markets? It should go bust, of course. Its partners
and investors should
suffer swift and onerous losses -- at the very least
as a signal to others to
stay away from risky investments in the future.
Instead, Long-Term Capital is being rescued -- not
with government
money (thank heaven for small favors) but through
not-so-subtle
pressure placed by government regulators on banks and
investment
firms to cough up $3.5 billion. It's a classic case of
moral hazard run wild.
Paul Volcker, the former chairman of the Federal
Reserve, was justifiably
outraged: "Why should the weight of the federal
government be brought
to bear to help a private investor?" Good question.
The rescuers were brought together last week by the
New York Fed at
the same time that Alan Greenspan was hinting in
Congress that the Fed
would cut interest rates.
The Fed's "official sponsorship" (Volcker's term) of
the rescue was the
result, said a Fed spokesman, of its "concerns about
the good working of
the marketplace, large risk exposure and the potential
for a disruption of
payments." In other words, the failure of Long-Term
Capital posed a
systemic risk; it could set off a cascade of other
failures, leading to a sharp
decline in bond and stock prices and perhaps
bankruptcies.
I am skeptical the effects would be so dire. Yes, some
bonds might
plummet, but that hurts current owners of those bonds.
Other investors
could benefit by being able to buy at the lower
prices. Why should the
Fed prevent them?
The truth is that no one knows what would have
happened in the
short-term if LTC had been allowed to fail. In the
longer term, the effects
are only too obvious: The rescue will encourage more
irresponsible
risk-taking by investors, just as the International
Monetary Fund's bailout
of Mexico encouraged investors to make inappropriately
risky
investments in emerging markets in Asia, leading to
more IMF bailouts
and a new moral-hazard cycle.
Perhaps the Fed did dampen systemic risk in the LTC
case, but as
Caroline Baum of Bloomberg Business News reported
Friday, "Traders
seem to be taking a different message away from the
whole affair. They
see an increase in moral hazard, with lenders making
increasingly risky
bets with the knowledge that someone will bail them
out, as the doctrine
of 'too big to fail' spreads from financial
institutions to corporations to
countries to private investors."
But we don't need to look to Mexico or Greenwich for
examples of
moral hazard run wild. Look to Capitol Hill, where a
bill is now racing
through Congress that would bail out companies that
made imprudent
bids for wireless telephone licenses.
The firms bid too high in a 1996 FCC auction. At the
very least, it seems,
they should lose the $1.3 billion they put up in down
payments. But,
instead, the House Commerce Committee on Thursday
unanimously
approved a deal that lets them renege on their bid
obligations and get
full refunds on what they've already paid the
government.
Not only is this bailout grossly unfair, it will also
encourage reckless
behavior in future auctions. And, speaking of reckless
behavior: There's a
parallel to be drawn between moral hazard in the LTC,
wireless and
IMF cases and moral hazard in the current scandal
involving President
Clinton.
Americans worry, for instance, that impeaching and
convicting Clinton
could hurt the economy and our world standing. This is
a legitimate
concern -- but I'm more afraid of moral hazard. If we
let powerful people
get away with doing bad things, they will not only do
them again and
again, but encourage others to follow their example.
The writer is a fellow at the American Enterprise
Institute.
? Copyright 1998 The Washington Post Company
=================================
>
