Fed Official Says Bailout of Institutions Caught in Subprime Collapse Raises Risk of “Moral Hazard”

Jun 9th, 2008 • Posted in: News

But Charles Plosser says being too rigorous about investments could dry up economy

NEW YORK
The concept of “moral hazard” was raised again in a major speech last week in which the head of the Federal Reserve Bank of Philadelphia warned of the consequences of encouraging reckless borrowing.

Charles Plosser said the Fed or any other central bank faces a risk if it intervenes as a lender of last resort in a bailout of those who cannot meet their loan obligations, according to a report from Forbes.

If lending to major financial institutions is “misapplied,” it can “effectively subsidize risk-taking,” Plosser said.

The Agence France-Presse reports that Plosser urged the government to develop clear benchmarks for situations that would merit Fed intervention.

Plosser noted that new and complex investment vehicles make risk-judging difficult, according to reports from Reuters and RTT News, but at the same time he maintained that regulating markets too heavily could inhibit financial growth.

The concept of moral hazard emerged on two levels in the recent turmoil surrounding the collapse of the subprime lending market: first, as an issue in the debate over whether giving loans to consumers with shaky credit encouraged eventual default, and later as a consideration in whether the government should bail out financial institutions buffeted by the ripples from the subprime collapse.

Plosser’s remarks about complex financial vehicles related to another underlying cause of the subprime meltdown: the slicing, dicing, packaging, and reselling of mortgages in complex investment vehicles that made it difficult to assess their riskiness and distanced the loan originator from the ultimate risk of the transaction.

Sources: Reuters, June 5 — AFP, June 5 — Forbes, June 5 — RTT News, June 5.

For more information, see: Related Newsline story, June 2 — Related Newsline story, May 27 — Related Newsline story, Mar. 17 — Related Newsline story, Mar. 10 — Related Newsline story, Feb. 25.

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3 Responses »

1. Ethics Newsline » News » Changing Perceptions of the Moral Culture of Money Undermine Economy, Writes NYT Columnist on June 16th, 2008 at 8:37 pm:

   [...] more information, see: Related Newsline story, June 9 — Related Newsline story, June 2 — Related Newsline story, May 27 — [...]

2. Ethics Newsline® » News » Ethical Investment Dilemmas Probed by World Press on July 14th, 2008 at 7:58 pm:

   [...] — Related Newsline story, July 7 — Related Newsline Commentary, June 23 — Related Newsline story, June 9 — Related Newsline story, June 2 — Related Newsline story, May 27. [...]

3. Ethics Newsline® » News » Congress Passes Massive Mortgage Bailout Bill on July 28th, 2008 at 8:52 pm:

   [...] 14 — Related Newsline story, July 7 — Related Newsline story, June 16 — Related Newsline story, June 9.  Print This Story  Email This [...]

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