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Bank of Canada Governor Mark Carney, joining central bankers everywhere with new details of their jargon-filled plans to flood the world with more jargon, declared yesterday in Montreal that "we are awash in moral hazard. If left unchecked, this will distort private behavior and inflate public costs." True enough, but can you guess where the moral hazard came from -- and who's doing the most to let it run unchecked?
The fact is we're awash in central bankers. From Mark Carney to the U.S. Fed's Ben Bernanke and the Bank of England's Mervyn King, central bankers are building up a massive regulatory regime of bank controls, new capital requirements, compensation rules, living wills, and too-big-to-fail structures. If we're already awash in moral hazard, why are they creating more of it?
Moral hazard is an old bit of insurance jargon that describes how people misbehave when they think they are covered against risk. Would you park your Mercedes in this dark Baghdadian strip mall crawling with drug dealers? Don't worry, it's insured. In the financial world, the classic moral hazard is deposit insurance on the first $100,000 of deposits. What if the bank should fail? Don't worry, it's insured. Beyond deposit insurance, the financial system is riddled with the phenomenon, with new moral hazards being created daily.
Most of the hazard creation these days is coming from central bankers. The high-profile sham of bringing bankers' compensation under control is the tip of the regulatory iceberg central bankers are guiding into place. In Montreal yesterday, Mr. Carney renewed his calls for bankers to peg their bonuses to long-term performance. This followed Ben Bernanke, head of the U.S. Federal Reserve, who last week announced guidelines that would require banking organizations to review their compensation practices "to ensure they do not encourage excessive risk-taking."
Since there is no evidence that compensation plans actually encouraged too much risk taking in the past, government attempts to control compensation create a double hazard. First, the controls mess with the banking industry's operations, thus disturbing healthy bank management practices. Second, the controls create a false sense of security in the public. Is your bank safe? Don't worry, the CEOs bonuses and everybody else's compensation is regulated to avoid too much risk, so it must be safe.
The central bankers opened their moral hazard floodgates last year when they cut interest rates to zero and dumped cheap money into the world system, buying up assets and generally reassuring everyone that taxpayers and inflation can be used to paper over bad debts, faulty risk models and flawed monetary policy. Having created the hazard, via cheap money and loose policy, Mr. Carney is now trying to reign it in. Last week he warned that he expected "prudence" from mortgage lenders and from average Canadians who are rushing to capitalize on record law mortgage rates by buying new homes. Typical of central bankers -- who've never seen a crisis they themselves had created -- Mr. Carney warned that bankers and home buyers would be to blame if the bubble created by cheap money were to burst.
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