With the Fed-engineered
bailout last week of the hedge fund Long Term Capital Management (LTCM),
the press suddenly discovered the concept of "moral hazard." This
term refers to the effect bailouts of bad investments have on future
investment decisions: With the precedent of bailouts in their minds,
investors are more likely to take imprudent risks.
While all three of the
major news weeklies picked up on this theme with LTCM, most still
havenít connected it with the International Monetary Fund (IMF) and
its role in bailing out investors worldwide.
"Washington and Wall Street
buzzed last week with outraged talk of Ďmoral hazard,í and for once
it didnít have anything to do with Bill Clintonís sex life," writes
John Greenwald in the October 5 Time. "Instead people were
talking about the danger created when government backing for private
lenders encourages them to take bigger risks ó in search of bigger
rewards." According to Greenwald, the "fear is that the Long Term
Capital bailout could encourage banks to make still more risky
loans, confident that the government wonít let them get into
The October 5 Newsweek
also notes the moral hazard aspects of the LTCM bailout. It quotes
former Federal Reserve Vice Chairman Wayne Angell, who said, "The
appearances of this are just horrible. We complain about Russia and
Japan and their insider dealings, and then the Fed comes along and
seems to be helping out every reckless fat cat." Newsweek
also quotes Lawrence Tisch, whose family owns the Loews conglomerate
and competes against those covered by the too-big-to-fail doctrine.
"His problem," according to the magazineís Wall Street Editor, Allan
Sloan, is that "giant competitors can take excessive risks while
Loews accepts lower returns because it has to be prudent."
Not to be left out, U.S.
News & World Reportís Phillip J. Longman and Jack Egan reported,
in the October 5 issue, that many "Wall Street observers are alarmed
by the precedent the New York Fed may have set by brokering the LTCM
bailout." They quoted an investor who said, "The Fed, which is
supposed to protect the sanctity of the dollar, is now stepping in
to bail out hedge funds," and wondered, "Who will be next, the
But all of this
acknowledgment of moral hazard hasnít, by and large, led the news
weeklies to apply it to the IMF. Only one story over the past four
months ó a September 28 U.S. News & World Report article by
Longman and Egan ó mentioned moral hazard in relation to the IMF.
"In effect, while the IMF punishes ordinary citizens by imposing
various austerity measures, it protects even the most foolhardy
foreign speculators from the consequences of their own mistakes,"
they write. "As a result, critics argue, the agency winds up
encouraging more overinvestment and the speculative booms and busts
that go with it."
But the lesson the two draw
is not that international institutions should first do no harm, but
that they should be given more power. Some experts, they report, are
calling for "a global New Deal ó a set of new institutions that
would save global capitalism from itself by taming its excesses."
Without quoting opponents of such ideas, they lament that with
regard to the creation of such new institutions, "strong leadership,
at least from the United States, isnít in the cards."
But at least they mentioned
moral hazard in relation to the IMF. Most other reporters still
havenít gotten that far. If a bailout of a high-profile hedge fund
in the U.S. sends the wrong signals to investors, then wonít IMF
bailouts overseas do the very same thing?