Moral Hazard Revisited?

 

When the financial crisis hit us hard in 2008, CNBC and Bloomberg pundits trotted out the term “Moral Hazard” on an all too frequent basis. Just what is Moral Hazard? During the Great Recession it was the first time that I had heard it since an Economic History class in 1971.

 

Simply put, Moral Hazard is when you have an economic set-up that does not penalize reckless market behavior. Some even say that it encourages it. Today, you often hear the term that some major banks are too big to fail. Smaller firms and financial houses are not so lucky. The big guys are often bailed out with taxpayer money and do not get punished for their mistakes.

 

So, in 2008, Lehman Brothers, was allowed to go bust but insurance giant AIG which had insured the majority of the infamous credit default swaps got bailed out. The banks who had foolishly gotten way over their heads on the swaps got funds and there were few consequences for their huge mistakes. More damningly, there seemed to be little effort or incentive for them to avoid such financial gaffes in the future.

 

So, if risky behavior works, the organization gets the profit. If highly speculative ventures blow up, the taxpayer is there to bail out the gamblers masquerading as financial titans. British financial writer John Lanchester described it as “the bad guys getting away with it.”

 

Why bring it up now? I am getting a bit edgy about some governmental action or possible future action that seems to reek of Moral Hazard.

 

Please do not misunderstand me. The Covid-19 epidemic is something that I hope is a once in a hundred-year event. And, so, I am not trashing Congress. They had to act quickly to avert disaster. Years from now, Monday morning quarterbacks and financial historians will write about what should have been done in 2020-21. 

 

I do think that the future can be fraught with moral hazard. What will happen when the next recession comes along? Let us assume that it is a mild or vanilla recession compared to the terrible blows of the Covid-19 downturn.

 

My guess is that millions of people will be clamoring for extended unemployment benefits, lengthy rent relief and debt accommodation that was built in to our 2020-21 national emergency. They will look for a bailout even though the difficulty is much milder than the current situation. Beyond individuals, watch for some large companies with their hands out, too.

 

Here is another one. Some progressive politicians are calling for a cancellation of all educational debt. When I first heard a few people discuss it, I was amazed. What about the millions of parents who took on a second job or a second mortgage to put their sons and daughters through college or graduate school and then paid it off? How about the students who worked throughout their college years and took six years to finish so they would not take on onerous debt? Is that fair to them?

 

A very erudite woman whom I know and is a self-proclaimed progressive hit me with a different angle. She has no problem with a proposal floating around to cancel the first $10,000 of student debt. She is strongly opposed to a total bailout, however.  Cancelling all debt, she stated, would subsidize the soon to be rich. A graduate of Yale Medical or Wharton Business School might have $200,000 in debt but could pay it off fairly swiftly once their careers took hold. Total debt forgiveness would be unfair in many ways.

 

My favorite example of someone who saw moral hazard and refused to play the game was John M. Nichols, a depression era banker. Nichols was president of the First National Bank but not of New York but rather Englewood, Illinois. Nichols was a rare bird and somewhat eccentric, I suppose. He did not believe in fractional reserve banking and was known as John M. (One Hundred Percent) Nichols. When the Federal Deposit Insurance Corporation (FDIC) was formed in 1934, Nichols refused to pay dues to the insurance fund. His attitude was that he was essentially being forced to subsidize his competition who were often unsound. Amazingly, Nichols was 100% solvent—he could meet all depositor claims at any time with cash or readily marketable securities. He left the banking business in Roosevelt’s 3^rd term and tore his bank building down. He called the FDIC “a damnable piece of political trickery.”

 

So moral hazard is not new but I fear it may raise its head again big time in the not too distant future. Will leaders have the courage to say NO at that time?

 

If you would like to contact Don Cole directly, you may reach him at doncolemedia@gmail.com

The Need for Immigrants

 

Recently, I was with a group of people and someone asked, “What is the biggest problem that we face as a society.” One fellow said creeping socialism but the rest of us all said global warming or climate change. The questioner than asked what do you think is the second biggest problem? Here the answers were dispersed and included too much government spending, the Federal Reserve, income inequality, health care costs and Covid-19. When it came to my turn, ever the contrarian, I said, “how about fertility rates in the western world.” This got a big laugh and I was not able to explain myself fully. This blog post will attempt to develop the thought properly.

 

Somewhere, in recent years, all of you have heard or read about “The Graying of the West.” Much of Western Europe, Japan, Canada and now the United States face a possible decline in population as we go deeper in to the 21^st century. This will likely develop in to a demographic tidal wave and put unsustainable strains on the social safety nets in all affected nations but especially Western Europe where the “provider state” offering some form of cradle to grave security has been in vogue for decades.

 

The problem that I see for the future is due to a decline in fertility rates. Simply put, if fewer people are born, then the population of a nation must become progressively older. If fewer people are of working age and many of the non-working are elderly this results in a lower consumption of goods and services which translates to a weaker economy. Of equal importance, fewer workers paying in to the  Social Security and Medicare systems which will make them very unstable.

 

How bad is it? Well, except for sub-Saharan Africa and a few pockets around the globe, fertility rates are moving down. The statistic that most demographers look at is where a country stands relative to Zero Population Growth (ZPG). This the “replacement rate” which, in the developed Western world, rests at 2.1 per women. If you at 2.1 or above, the population will remain stable or grow. Below it and a nation is on a collision course with a cutback in services, bankruptcy, or a lower standard of living.

 

To put things in perspective, the fertility rates in Niger and Angola are the highest in the world at 6.91 and 5.9 respectively.

 

Here are rates in some countries in the developed world:

 

Ireland                         1.93

United Kingdom          1.86

Sweden                       1.86

United States              1.84

Canada                       1.57

Spain                          1.52

Italy                             1.47

Portugal                      1.42

Japan                          1.38

Taiwan                        1.07

 

Source: The World Factbook, CIA

 

You are probably asking what the rate is in mainland China. The country has abandoned their “one child rule” but families are not getting larger (I could not find solid numbers for China). Also, many countries around the world offer bounties for a 3^rd or 4^th child but they have been largely unsuccessful in moving the needle on fertility rates.

 

So, here is the problem that few in the media talk about in any depth. If a country wants to maintain the services that they have now but the next generation of taxpayers are not being born, then new workers (aka taxpayers) will have to be imported.

 

This is where I have a huge problem with politicians of both major parties in the U.S. Immigration brings benefits in that you have eager people coming to your country be it Italy, Spain, the UK or the United States who are eager to succeed and may be leaving a difficult or limiting environment. Long Term, the benefits are big and clear as the taxpayer base gets right-sided and services continue. Short term, it can affect housing, schools, and health care on a LOCAL basis and localities are ill equipped to deal  with the influx of newcomers. Governments all over the globe seem to mess this up and not take national action. So, some people whip up bad feelings about immigrants not realizing that they are the ticket to a comfortable old age for many.

 

Canada is one exception. They actually recruit doctors, engineers and other people with special skills. Talented foreign graduate students are often put on a fast track to Canadian citizenship and the nation benefits from an influx of unusually skilled people.

 

Why the decline in fertility rates in the developed world? Well, people are marrying later and women who are successful in the workforce are enjoying their careers. Also, work and fewer children are an economic necessity in many if not most cases. For a tough analysis of this, may I recommend that you read SQUEEZED by Alissa Quart subtitled “Why our families can’t afford America”? (Harper Collins, 2018)

 

So, I see this as one of the great issues of our times. I sincerely hope that it gets more traction in the media and with the public and soon.

 

If you would like to contact Don Cole directly, you may reach him at doncolemedia@gmail.com

The Slender Thread

A long time ago I was a freshman in college. There was a columnist for William F. Buckley’s NATIONAL REVIEW complaining about student riots in Paris led by a fellow known as Danny the Red. The prose did not exactly sparkle but there was one line in it that has stuck with me. He wrote “Civilization hangs by a slender thread.”

As we have suffered with Covid 19 since March 2020, people verbally are echoing the tone of that 53 year old rant. When I look at history, I see something different.

To me, the big issue with the Covid 19 epidemic is the speed of how it spread plus how it shut down economies across the globe. Some 11 million Americans lost their jobs very quickly; perhaps faster than any other time in our history. Historically, other devastating events tended to move much more slowly.

Some people think that the depression happened immediately after the the stock market crash of 1929. It wiped out a relative few as less than 10% of Americans were shareholders at that time. And, did you know that stocks doubled in value over the 12 months following the Great Crash? The economy and stocks then fell and bottomed out in 1933.

The influenza epidemic of 1918-1920 moved across the country slowly (my paternal grandfather died of it) as people had little mobility then and over 30% of the population remained on farms and were somewhat isolated from big cities.

Some media outlets disturb me as do some politicians who say how great things were before the pandemic hit. They WERE great for a large number of us but not the overwhelming majority of Americans. Consider these facts:

1) Yes, the unemployment level in the U.S. was the lowest since 1969 in January, 2020. Yet, millions had minimum wage service jobs.

2) The Federal Reserve essentially reaffirmed their statement of three years earlier that approximately four in 10 Americans could not afford a $400 emergency room visit or car repair.

3) Some 17% were unable to pay their current bills in full every month (this includes minimum payments on credit card debt).

4) In 2018, one quarter of Americans skipped necessary medical care as they could not afford it.

5) 25% of the labor force had no retirement savings at all.

6) One in four people under 35 had more than half of their take home pay going to rent.

Clearly, when things seemed good due to a bulging Dow Jones Industrial Average, about half of America was living on the edge.

I have always thought of Henry David Thoreau’s 1850’s quote that “most men live lives of quiet desperation.” Some say that he meant that they got wrapped up in money, possessions, and recognition but, to me, he was referring to the precarious financial existence that many faced. Did you know that the United States abolished debtors prisons in 1833 while Britain finally shut theirs down in 1869. Don’t believe me? Read Charles Dickens.

Another aspect that I have not read much about is the food jeopardy that many have faced in recent months. Why now? Well, society has changed. In 1820, 72% of Americans lived on farms. By 1850, it had dropped to 64%, 30% as mentioned above in 1920, and less than 2% today. During previous financial crises, people often returned to the family farm or could work for room and board. There is no such option today.

So, as is true for all of us, we hope the pandemic is under control soon. And, we wish to see a rebound in the economy that is significant as well. Yet a look at history tells us that Thoreau was correct in the 1850’s. A majority of us (not readers of this post) were struggling before the pandemic hit.

If you would like to contact Don Cole directly, you may reach him at doncolemedia@gmail.com or leave a message on the blog.