Development Trap, Moral Trap!

There ain’t no such thing as a free risk. However, when the lower class witnessed the economical development and boom of their country and were also dreaming of the life style of the rich, will they take risk to get a free lunch?

When we try to recall the cause of the financial crisis ten years ago, it’s not difficult to find out that ethic problems take place all along the way because all the economic actors were holding the fluke mind of “playing the others’ money”. That is how moral crisis happened. We can definitely not control and underestimate the power of human nature, but the irrational decisions of individuals will finally lead to the outbreak of a financial shock. And when the citizens tried to lead a well-being life, they found that they were trapped in the cycle of poverty. Why could that happen? I attempt to build a vicious circle of having little and moral crisis, from the poor citizens and the financial agency to the government step by step, to trace the root of the puzzle.

The “Dark Art” behind the devil circulation

“The largest problem of mankind are human beings: We constantly make bad decisions even if we know perfectly well that we are in the process of making a bad decision.” This is good to explain why people take risky actions intentionally, when they know that the economic behaviour is ethically destructive and harmful to others’ interest. Everyone is chasing the individual beneficial and will make poor choices when they see that the result can be partly shared by others. Before we get to the relationship between moral crisis and financial crisis in details, let’s have a look at the  historical exploration of moral hazard:

图片1

Sources: The Wall Street Journal, The New York Times, Financial Times, The Guardian 1982–2010.

As the graph shows, a sharp increase in the usage of the term “moral hazard” appeared from 2007, which is coincide with the outbreak of the sub-prime crisis in the USA. Moral hazard is defined as the action of economic participates that maximize their own beneficial with the costs of someone else, especially when they realize that the other people will beat cost of their own risks.

Start from the consumers

It’s necessary to begin the moral risk circulation from the poor citizens with American dreams, because they are the most basic participators of the game and the original decision maker. They did their utmost to survive under huge financial pressure because of the high price standard and found it hardly to afford a big and bright house. Then, there came an opportunity to change this dilemma: the government encouraged consuming and the banks provided loans, helping the poor to realize their dream. Some of them indeed found themselves difficult to pay back the interest, but obviously, their desire and the teaser rate over-weighted the concern for the future. They were very glad to become the borrowers because they could be homeowners immediately with a small quantity of expenses. What’s more, they knew that the risk of failing to repay was taking by the creditor. To some degree, poverty diminished cognitive capacity and led to moral crisis at the same time. Whatever happens, they would get compensate and relief from the government. So the poor borrowers with low economic capability still dared to buy what they could not afford. Moral hazard arouse and risks were transferred to the loan providers.

Relay to the financial institutes

The first part of them is private commercial bankers. They would not hesitate to take over the inordinate risk because they knew that they were too-big-to-fail, either to the size or to the complexity. Besides, they profited with the expense of depositors and loss of bankruptcy could be spread to all the equity-holders. The second part of the notorious culprits are what we called Fannie Mae and Freddie Mac. They were motivated by the short-term bonus payments and expanded sub-prime mortgage, regardless of the credit rate and the repaying ability of the borrows. They knew that the government-sponsored enterprises would come to the rescue, because the government would throw out bailouts to save them from falling down to the cliffs. In addition, they attempt to rely on the third important player of the game, the investment banks, who created financial derivative instruments, which changed the mortgage into securities, thus ignored the originator of the loan. They would not hesitate to gain the profit from the dangerous action, as they were also betting with the third’s asset and got support from the incentive capital policy. So they wouldn’t care if the counterpart was a homeowner or a speculator. Moral Hazard was in that way passed on and deepened.

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Finally, the government reacted to the crisis with subsidies, bailouts and loose monetary policy. The Federal Reserve set interest rates very low, the government subsidized in order to grantee the average living standard, and the politicians still tried to promise people with more houses to get votes. They accepted the ever rising inflation because they fount it easy and cost little to print money. The push power for the government to do so is also moral hazard. Because they were supporting the poor financial sectors with the money of taxpayers. The risk went back to the citizens and companies and the circulation of moral crisis completed. What they generated together are over-borrowing, bubbles, also stagflation. And they had to pay price for their greed and selfishness eventually, remaining in the poverty trap.

 

References

Claassen, R. 2015. Financial Crisis and the Ethics of Moral Hazard. Social Theory and Practice, 41(3), 527-551.

Dowd, Kevin. 2009. Moral Hazard and the Financial Crisis. The marine fauna of the carboniferous in the Netherlands /. Uitgevers-Mij. Ernest van Aelst, 141-166.

Kling, A. 2010. The financial crisis: moral failure or cognitive failure?. Harvard Journal of Law & Public Policy, 33(2), 507-518.

Mani, Anandi, Sendhil Mullainathan, Eldar Shafir, Jiaying Zhao. 2013. Poverty Impedes Cognitive Function. Science, 341, 976-980.

Shah, K. Anuj, Sendhil Mullainathan, Eldar Shafir. 2012. Some Consequences of Having Too Little. Science, 338, 682-685.

Umlauft, T. S. 2014. Regulators’ irrational rationality and bankers’ rational irrationality: too big to fail, self-regulation, moral hazard and the global financial crisis, 2007-2009. Social Science Electronic Publishing.

Victor Troacă, & Victor-Adrian Troacă. 2010. Moral hazard – case or effect of the economic crisis. Analele Universităţii Constantin Brâncuşi din Târgu Jiu : Seria Economie, 1(4), 83-91.

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