Is moral hazard real?
After the Fed's "liquidity injection" last Friday the calls for a rate cut are deafening, with predictions that it will happen even before the next scheduled Board of Governors meeting in September.
Comparisons abound to 1998 when in the wake of the Russian default and the Long Term Capital meltdown, Alan Greenspan lowered rates by 750 basis points and created the famous Greenspan put, which leads me (finally) to my point and my question.
Wouldn't public perception of the existence of the Greenspan put have created moral hazard? Wouldn't the idea that in a crisis the Fed will float away problems encourage people to invest heavily in junk bonds and securitized sub-prime mortages? In other words, doesn't the bailout of 1998 have at least something to do with the current crisis?
People have invested so heavily in highly risky assets that the spread between them and treasuries had become vanishingly thin. People seemed to be chasing yield without regard to risk, and now they are paying the price.
Is another bailout the right answer? In the colorful idiom of central banking, Should "Helicopter Ben" exercise the "Greenspan Put", or is moral hazard a serious enough problem that we should stop creating it regardless of the short term discomfort?
Labels: economic policy