My son and I email our thoughts on the state of the world, the importance of science, religion and sometimes economics. He is a bit to the right on the economy – I’m a bit to the left. This is an email I sent to him about what is going on the in economy right now.
Morning Son.
There is an interesting debate happening at CNBC right now that touches on the conversation we have been happening. You might be interested.
Rick Santali is a reporter that works in the trading pit at the CMI. He went off on a rant last week about the government promoting bad behavior by bailing out banks and homeowners who made bad decisions. He is right of course the bailout does promote bad behavior as I’m sure you will agree.
Today Rick and some of the other reporters in CNBC went over it again but during the debate they started to talk about the moral hazard problem. Moral Hazard is not what the talking heads called it, they called it the ‘Fire House Choice’ but it goes like this.
Your neighbor is an idiot. He smokes in bed all the time and has started several small fires all of which have been put out quickly when the neighbors call the local fire house – but he continues to smoke in bed. He’s a slow learner. The neighbors decide that the next time a fire starts they will simply not make the call as a drastic but necessary instruction on fire safety. After all why should the home owners continue to pay increasing fire house taxes to support this idiot’s bad habit?
Sure enough one night the neighbors smell smoke coming from the idiot’s house but DO NOT make the call. The fire increases, the idiot escapes but his home is a total loss. A lesion learned the hard way. All is good. But then the neighbors look around at their own houses and realize that the embers from the idiot’s house have started all their own homes on fire. The fire department is quickly summoned but because of the magnitude of the many fires all the homes are lost.
The lesson from this is that – sure the idiot learned not to smoke in bed after being taught a harsh lesson but the neighbors also learned the hazard of teaching that lesson.
Should they have called the fire department?
The problem going on now is much the same and the results could be the same it we don’t make the call. The bail out money is not intended to keep the bank owners and car manufactures and home owners solvent. It may be a result but it is not the intent. The intent is to keep the defaults from flowing into the much larger economy and burning the whole thing down.
During the ‘20s the Hoover administration decided to not make the call and the fire got going much worse than he or the Republicans’ thought it ever could. At one point 1/3 the people were out of work and many were starving. When Roosevelt became president he decided that he did need to make the call and started many WPA projects (my dad was on one of them) and in the end the fire was put out.
Many conservatives to this day will say that the moral lesion was not learned and that what we have now is the result. They are absolutely correct. We started the damn fire over again. They say that Roosevelt only prolonged the agony of the depression by stepping in with the fire hose. "After all", they say "the depression was on the way out when he started to prime the pump". They may have been right.
Rick Santelli may be right now and it might be better to let the fire burn out the stupidity but remember that hazard in that moral lesion.
Should we make the call?