Moral hazard is a tricky concept. Try it on the Oxford Concise or on good old Roget and you draw a blank.
But for something apparently so abstruse moral hazard has grabbed an indecently large slice of media attention since the financial crisis came sweeping towards us back in 2007. And it won’t go away – as events in Cyprus (or maybe Berlin) have once again demonstrated, grappling with moral hazard can addle peoples’ brains.
Five or six years ago the argument was about banks. No less an intellect than Sir Mervyn King insisted bailing out a bank whose imprudence had got it into trouble would merely encourage it to repeat its excesses.
Given what we know now we can see that, for all its intellectual purity, the principle was the wrong one for the times; the banks had already embraced imprudence beyond all imagining and the consequences of letting them fail were unacceptably high. We proved it; remember Lehman Brothers?
Since then our lords and masters have struggled to find a balance between the natural desire to make people suffer for their mistakes and the well-founded fear of unintended consequences. Generally it is fear that has gained the upper hand. Banks have been bailed out by taxpayers; feckless Club Med countries have swallowed up billions of euros to stay afloat; over-extended (“zombie”) companies stagger on thanks to artificially low interest rates; and homeowners in negative equity keep the roof over their heads so lenders don’t have to recognise a loss.
The pragmatic view is that these outcomes are probably the least-worst, given the likely alternatives. The financial system is recuperating, the eurozone hasn’t fallen apart and after a terrible battering much of the developed world economy is teetering towards recovery (the intact eurozone excepted). At times a total collapse of life as we know it seemed a real possibility, yet we have survived.
But it does leave a nasty smell. Take the banks, for example. As corporate entities they have certainly suffered for their sins and the party line is that lessons have been learnt. Yet companies – including banks – are not autonomous entities: remember, companies do not pay taxes, it is their employees and customers who pay “corporate” taxes. Some bankers have lost their jobs, which is no bad thing given the damaging uselessness of whatever it was they were doing.
But judging by their behaviour, others have learnt nothing. Witness the swift return to bonuses as usual. Nor is it particularly evident that the Southern Europeans really get the plot; certainly they haven’t explained it to their bewildered citizens.
Moral hazard is real; let people off the hook and they do go back to their old ways. So the pressure is on to find other means to make them behave; since politicians are involved it is hardly surprising that unintended consequences are flowing thick and fast.
Back to the banks: if we can’t trust them to behave then we look for alternative sanctions. So we hit them with wave after wave of fines, we tacitly allow bogus PPI claims to rip billions out of them and we meddle with remuneration policies. The results are as predictable as they are perverse: balance sheets hit by new provisions struggle to recover and pay loses all contact with performance. Brilliant.
And so to Cyprus, which has the misfortune to be small enough to be kicked around. Suddenly moral hazard overrules fear and innocent bank account holders must be made to pay. Well, in the end maybe it is the possibly less innocent depositors with more than €100,000 who take the hit, but a Rubicon has been crossed; money in a bank may not, after all, be safe. Today Cyprus; tomorrow who knows?
This may not be a Lehman moment – yet – but the unintended consequences are beginning. Moral: if you are going to turn a blind eye to moral hazard, at least be consistent.
• Peter Bickley is a consultant economist