There is something about man that leads him or her to excess. This tendency to excess, to take advantage of opportunity to reward the pleasure or greed centres of the brain is part of the reason why economies and markets tend to excess, and the imbalances this creates leads to financial, market and economic shocks.
Man may only act rationally under certain constraints and these constraints are not operational when temptation is too close to bear.
But then we also have moral hazard, which is the removal of constraints and, under certain conditions, creates a certain rationale or encouragement of excess that places the entire construct at even greater risk. Moral hazard and decisions that lead to moral hazard create a false reality that subverts the needs and structures of the real world.
It is clear that relaxation of financial regulation and the low interest rate policy of many central banks (note the “Greenspan put”) helped create a false financial reality that has been imploding and threatening the world economy for some 4 ½ years now.
I cannot help thinking that continued central bank intervention (in particular the Federal Reserve’s) in the form of quantitative easing and guarantees with regard to interest rate policy and repurchase agreement collateral has helped perpetuate this alternate financial reality. When I see the risks MF Global (and god knows how many other firms) have taken with respect to Eurozone debt and repurchase agreement structure, and the ever present financing and solvency risks of the banking system, I am reminded of how critical a risk moral hazard remains.
We are still heavily enmeshed in this world of financial excess and the only way in which this excess has been contained, so far, has been to continue to devise policy that encourages it. We will only ever get back to normality when the encouragement of moral hazard is withdrawn and excess debt has been expunged from the system.
We are still so very far away from getting back to normal that I am becoming increasingly torn between supporting the need to maintain the financial system and the need to wash the system of the risks and moral hazard.
No rebirth without death, no rising phoenix without the fire.