Russ,
That was a very informative and useful article; however, I must take exception to particulars of two of your examples of Moral Hazard.
<<(2) a bank loan officer loans out depositors' money to a high-risk project at a high interest rate knowing the bank's depositors are covered by a government-sponsored deposit insurance program>>
Deposit insurance plays absolutely no role in a lending officer’s decisions.
Why do they make risky loans? Some do it because they are incompetent. Others do it because they can’t say no, especially to friends and/or highly regarded members of the community. Others do it because they are risk lovers, to use your terminology, and feel compelled by competition. Still others do it because there is something in it for them. The latter occurs more frequently than you might imagine. Rather than clutter this post, I’ll give real life examples in a follow on post of why high-risk, fraudulent loans are made and their consequences.
<<(3) foreign investors, assuming the host government will "bail out" failing banks, loan money to a bank the financial condition of which is suspect due to a lack of transparency>>
I can’t think of a single case where an insured institution has been “bailed out”. I can think of numerous instances where depositors have been bailed out. In fact, during the S&L crisis the FDIC paid off all deposits without regard to size, which far exceeded its mandate.
There is a common misconception that S&L’s were bailed out. In fact, the surviving institutions that had managed to avoid the disastrous consequences of disintermediation, then avoided the pitfalls and fraudulent activities associated with expanded lending authority, were required to pay off RTC’s bonds through higher FDIC insurance assessments. So the good guys’ reward for sound management was to be put at a competitive disadvantage to commercial banks.
Now there have been attempts to use political influence to save certain institutions from the reach of regulatory authorities. But this belongs in a different category.
One case that comes to mind is Superior Federal. Another was an institution that tried to persuade Henry Gonzales to insert a provision into FIRRERA that would bar the FDIC and the OTS from taking down the largest S&L in the state where the institution was domiciled. Guess which institution was the largest. The attempt nearly succeeded, but not quite.
Perhaps in retribution, that institution was the first in the country to be taken down after FIRRERA was signed into law.....the next day. |
