I’m not a banker, economist or in any profession directly related to the finance industry so I might not understand everything that is going on and my interpretation of events might be way off-base, but it would seem to me that something is really rotten in the finance industry.
Firstly, we know that people working in the finance industry earn a relatively, if not absurdly ridiculously, high compensation compared to professionals in other industries.
When a certain bank like Bear Stearns is doing badly, what happens? A government body steps in to bail it out. Now, I understand why they say they need to do it - to prevent the whole system from collapsing.
Bush Supports Fed’s Actions, but Critics Quickly Find Fault
Officials says that people involved with Bear Stearns didn’t get away easy - shareholder value was wiped out. Yet, that is a rather inaccurate picture - some people involved with Bear Stearns did get away with something in terms of salary and bonus compensation. These are the bankers. Unless they used their compensation to buy shares in the company, what they earned was pretty much safe when shareholder value got wiped out. Funny thing is, they get to keep their compensation for the work that got the bank in the position to experience a collapse.
Who bears the cost?
From: Rescue Puts Credibility of the Fed on the Line
And no one knows how much the Fed could lose if the borrowers fail to repay their loans or whether hundreds of billions of dollars will ultimately have to come from taxpayers to shield the nation’s financial system from ruin.
If the rescue effort fails, taxpayers could indirectly wind up having to assume part of the cost. Tax revenue does not pay for the Federal Reserve’s operations, including the rescue effort, because the Fed earns income from its trading operations.
But the Fed does pay the Treasury a regular stream of money every year out of its trading profits, lowering the amount it needs to borrow from outsiders. If the new borrowers on Wall Street are unable to repay, and if the market value of the securities they pledge as collateral continues to drop, the losses will come out of the Fed’s payments to the Treasury.
Why is the Fed doing what it is doing?
From: Plunge Averted, Markets Look Ahead Uneasily
“They stand committed to protect the system,” said Richard S. Fuld Jr., the chairman and chief executive of Lehman Brothers
Which system is being protected? Is it the one where people can be reckless with other people’s money to earn high compensation for themselves without worrying about any consequences when things go south?
From: When a Safety Net Can Lead to Risky Behavior
It describes the possibility that people will take foolish risks when they believe that they will be protected from the consequences of their decisions. In this case, the critics are worried that investment firms will repeat their recent run of reckless investments, based on a belief that the government will bail them out again.
The classic examples of moral hazard involve insurance. When people can insure themselves against a bad event, like a car accident, they may become more willing to engage in dangerous behavior that could lead to that event.
Seems like it to me.
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