Charles Hugh Smith: When Risk Is Offloaded Or Hidden, It Creates Moral Hazard.

Moral hazard

Moral hazard (Photo credit: jcbear2)

Risks have consequences, and when these consequences are divorced from risk, it creates moral hazard. This means the person taking the risk will not be in a position to weigh all the consequences of the risk, before he makes a decision to start, or continue a particular activity. In this article titled, The Source Of Systemic Crisis: Risk And Moral Hazard, Charles Hugh Smith, at oftowminds.com, explains risk and moral hazard as it pertains to how insurance works, as compared to how noninsurance insurance works. There is a big difference between life insurance, fire insurance, car insurance, on the one hand, and Government programs like social security insurance, medicare insurance, medicaid insurance on the other. Here are some excerpts from the article.

There are all sorts of candidates for the root cause of the systemic global financial crisis, but if we separate the wheat from the chaff we’re left with risk and moral hazard. Pointing to human greed and cupidity as the cause doesn’t identify anything useful about this era’s crisis, as human greed, self-interest and opportunism are default settings.”

“The key to understanding risk is to ask where it is being offloaded. Risk cannot disappear, it can only be transferred or cloaked.”

Moral hazard is a fancy way of saying those who have no risk act quite differently from those burdened with risk……Moral hazard means risk has been separated from consequence.”

“The systemic back stopping of speculative losses incurred by banks was and remains the source of the global financial crisis. Simply put, systemic moral hazard leads to self-reinforcing feedback loops of risky bets and catastrophically poor decision-making by speculators and policy makers.”

In his next article titled, The Grand Experiment: Offloading Risk Onto the State, he explains that offloading this risk onto the State merely concentrates the risk and the potential for collapse. The illusion that the risk has disappeared, because it is seemingly offloaded into an endless pool of tax dollars and borrowing, doesn’t make the illusion true. The consequences have to be faced at some point in the future. Here are some excerpts from the article.

“Before the rise of insurance and government income-security programs, fortunes were lost when ships sank in storms, farms were lost to drought, and families plummeted into impoverishment when the primary wage earner died from accident or illness. Nature, not finance, was the dominant source of risk.”

“The pressing need to manage risk in the real world spawned the financial world….Risk management also led to the futures market, as cargoes were sold in advance to fund the extraordinarily costly voyages. This in turn led to financial markets and options trading, as these contracts were traded during the voyage….The joint stock company, where the risk is distributed to owners of shares, is not just a way to raise capital but a way to manage risk by distributing both profits and losses to voluntary participants.”

“All of these financial mechanisms were developed to manage natural-world risks. In a very real sense, risk has been offloaded from Nature to the economy, and specifically to the financial realm.”

 “Financial crises in the early 20th century led to financial risk being offloaded onto the state;”

“The unspoken assumption is that the state can absorb essentially infinite risk because it can tap the earnings of a large pool of involuntary contributors (taxpayers) and borrow money to carry it through periods of slow growth or heavy losses”

The problem is the state’s ability to tax/print/borrow money to cover payouts and losses is not infinite. Having transferred virtually all systemic risks to the state, we presume the state is so large and powerful that a virtually limitless amount of risk can be piled onto the state with no consequences.”

His next article titled, The Grand Experiment Part II: Unlimited State Creation Of Credit And Cash, talks about how Government borrowing and the Fed’s electronically printing counterfeit money, make the problem worse. Borrowing and printing can’t fix a problem that was brought about by borrowing and printing. Here are some excerpts from the article.

“In the quasi-religion of Big Government Borrowing as the risk-free fix to all crises,”

“This dominance of moral hazard discourages integrity and responsibility and incentivizes risky speculation and irresponsible choices and lifestyles.”

 

“Systemic financial crises can be fixed with More of the Same–just unleash an even larger tsunami of free (borrowed) money to wash away the losses and financial ills.”

 

The problem with this faith is that the open-ended concentration of risk in the state creates open-ended demands for backstops that eventually exceed the state’s ability to borrow money.”

 

“Borrowing and printing $10 trillion hasn’t fixed anything; it has only raised the reservoir of risk to the top of the dam. Cracks are opening as the pressure builds, and we should not be surprised when risk and consequence reconnect and the dam gives way”

 

I love reading Charles Hugh Smith’s articles because of his unique way of looking at how the world works. These articles on risk and moral hazard should open our eyes to the unsustainable path we are on. In my last post titled, Is The Economy Improving, It Depends On How You Define Improving, we talked about how consumption is outpacing production, which means we are destroying wealth not producing wealth. This also shows the unsustainable path we are on. When you add this to what CHS has explained, it should scare you.  Politics has made it almost impossible to roll back Government intervention, or the status quo, as CHS likes to say. The politics will change when we change, and that can only happen if we educate people about where we are, and where we’re headed. We all have to our part in educating ourselves and others. I thank CHS for the contributions he’s made to this educational process.

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