Bear Stearns Investment Bank is one of many banks that allowed greed to get the better of common sense over the past decade and invested heavily in “subprime” mortgages (ie – loaned money for people to buy houses larger than they could really afford). Now of course the chickens have come home to roost, so that all these banks are in serious financial trouble, which has prompted the government to temporarily bail out Bear Stearns with a short-term federal loan funneled through J.P. Morgan Chase and Co.
The argument for such help is reasonable enough – if Bear Stearns is forced into bankruptcy it will essentially have to sell its weak and bad subprime loans at bargain basement prices, which will force down the value of every other bank’s subprime loan portfolio, forcing more banks into bankruptcy and perhaps starting a collapse of the whole financial system.
Nonetheless, there is a fundamental problem here. The government has created yet another moral hazard. In essence, Bear Stearns has profited handsomely over the past decade from the (unwise) risks it took, and now is being saved from the consequences of its poor management with what in the end are really taxpayer dollars. Senior Bear Stearns management have made fortunes in personal income on this unwise risk over the years. For example, Samuel L Molinaro Jr ,Executive VP/CFO/COO at The Bear Stearns Companies, Incorporated, earned $250,000 in salary, $12,967,500 in bonuses, and $13,336,250 in long-term compensation, for a total of $26,553,750 for the year 2007, not counting some $22 million more in unexercised stock options, for making such unwise decisions! Yet he will bear little or none of the costs of his poor judgment. Bear Stearns investors will share some of the pain for their own poor judgment, but not as much they should in a truly free market system.
Its not that I’m against the government stepping in to prevent a collapse of the financial system (though one might ask why the government didn’t regulate bank practices better in the first place), it’s that I think those who profited handsomely over the years by the risk-taking ought to bear some substantial portion of the pain of recovery. It’s true the senior managers may find themselves out of a job soon, if Bear Stearns is taken over by someone else, but they will be multimillionaires out of a job, forced to spend their idle days in one of their various houses or on one of their various boats, or sitting on the Boards of Directors of other companies at handsome retainers.
Somehow this doesn’t seem right. If I can take unwise risks with the assurance that the government will bail me out when things get bad, clearly I have an incentive to take those unwise risks. There is a large upside for me and a very small downside. That is a moral hazard.
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