Tuesday, 2 December 2008

Reckless caution or moral hazard?

A new term has entered the political lexicon in recent days, describing the reluctance of banks to lend money at levels previously seen. Such "reckless caution" is said to be causing further economic problems by stunting consumer spending, one of the key drivers of the economy in the past decade, now replaced by the Government advancing its own spending programme in an effort to stimulate the economy. But is it reckless?

The banks get told on the one hand that theyve been stupid with their policy of lending to anyone and everyone at rates which were clearly unacceptable and yet when the banks take the action they believe to be right, that of removing the drip of credit to protect themselves for the future, they get criticised for it accused of endangering the economy. I disagree that such action is recklessly cautious. If the banks do not take the action they are doing will we ever learn the lessons that the banks have, that such lending is unsustainable and was based upon us borrowing against hopes of continuing growth?

Moral hazard is a key principle we must never forget in relation to this credit crunch. Banks do learn from their mistakes and are rightly arguing that the action they are taking will be of long term benefit to the country, even if such benefits arent noticed now, which is why I warn against heavy government interference as is to be promoted in the Queens Speech. Banks will never lend in that way again so such action by the Government is effectively pointless.

The principle of moral hazard applies to us as much as it applies to the banks. We are credit junkies and we need to learn that we helped cause this by taking the credit when it was offered and to now wean ourselves off, even if it takes longer to recover from the recession.

1 comment:

Matt B said...

Credit consumption actually has very little to do with this mess. It rests in the mostly theoretical off-setting of debts against credits. The problem mainly being that a select few American financial types had found a way to repackage bad debt as top quality investments and then used smoke and mirrors to index and cross link it to make much more than there actually was.

When the unregualted debt creation started to bite it was the banks everywhere that got stung. The banks then realised that they could not trust each other but in turn needed to still be trusted because things only worked while they were borrowing and lending insane amounts to each other all day every day.

Now is simply an expensive time to use credit.