Friday, July 22, 2011
Eurozone can sideline moral hazard
July 22, 2011
Betting on bail-outs is generally a good idea. When a government steps in to rescue a financial institution, it has usually decided to do what it takes to keep that institution alive. It ill behoves investors, with no monetary printing presses at their disposal, to bet against them.
Investors understand this. Hence, the extraordinary snap back in the prices of European bank shares, and of the sovereign debt of peripheral European countries, ever since the details of the latest deal “to save the euro” began to emerge. Traders were following a well-established template. Whatever their doubts about the longer-term feasibility of this package, the only sensible short-term response is to buy.
Government bail-outs are sometimes necessary. It is dangerous to be too much of a purist over market discipline when real and avoidable human pain is at stake. But they carry a penalty in terms of moral hazard. This term refers to people’s extra propensity to take risks when they know they have some insurance.
Posted by Yulie Foka-Kavalieraki at 9:47 PM