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Posts Tagged ‘Moral Hazard’

Price fixing is illegal in the private sector, but unfortunately there are no rules against schemes by politicians to create oligopolies in order to prop up bad government policy. The latest example comes from the bureaucrats at the International Monetary Fund, who are conspiring with national governments to impose higher taxes and regulations on the banking sector. The pampered bureaucrats at the IMF (who get tax-free salaries while advocating higher taxes on the rest of us) say these policies are needed because of bailouts, yet such an approach would institutionalize moral hazard by exacerbating the government-created problem of “too big to fail.” But what is particularly disturbing about the latest IMF scheme is that the international bureaucracy wants to coerce all nations into imposing high taxes and excessive regulation. The bureaucrats realize that if some nations are allowed to have free markets, jobs and investment would flow to those countries and expose the foolishness of the bad policy being advocated elsewhere by the IMF. Here’s a brief excerpt from a report in the Wall Street Journal:

Mr. Strauss-Kahn said there was broad agreement on the need for consensus and coordination in the reform of the global financial sector. “Even if they don’t follow exactly the same rule, they have to follow rules which will not be in conflict,” he said. He said there were still major differences of opinion on how to proceed, saying that countries whose banking systems didn’t need taxpayer bailouts weren’t willing to impose extra taxation on their banks now, to create a cushion against further financial shocks. …Mr. Strauss-Kahn said the overriding goal was to prevent “regulatory arbitrage”—the migration of banks to places where the burden of tax and regulation is lightest. He said countries with tighter regulation of banks might be able to justify not imposing new taxes.

I’ve been annoyingly repetitious on the importance of making governments compete with each other, largely because the evidence showing that jurisdictional rivalry is a very effective force for good policy around the world. I’ve done videos showing the benefits of tax competition, videos making the economic and moral case for tax havens, and videos exposing the myths and demagoguery of those who want to undermine tax competition. I’ve traveled around the world to fight the international bureaucracies, and even been threatened with arrest for helping low-tax nations resist being bullied by high-tax nations. Simply stated, we need jurisdictional competition so that politicians know that taxpayers can escape fiscal oppression. In the absence of external competition, politicians are like fiscal alcoholics who are unable to resist the temptation to over-tax and over-spend.

This is why the IMF’s new scheme should be resisted. It is not the job of international bureaucracies to interfere with the sovereign right of nations to determine their own tax and regulatory policies. If France and Germany want to adopt statist policies, they should have that right. Heck, Obama wants America to make similar mistakes. But Hong Kong, Switzerland, the Cayman Islands, and other market-oriented jurisdictions should not be coerced into adopting the same misguided policies.

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I get a lot of email asking me about Greece, especially since I don’t give the issue much attention on the blog. I am paying close attention to what’s happening, especially since Greece is a canary in the coal mine. But I generally try to avoid being repetitious, and anything I say now would replicate what I said in my initial blog post in February. Simply stated, if you subsidize bad behavior, you get more bad behavrior. But now that a bailout request is official, I suppose some additional commentary is appropriate. The editorial page of today’s Wall Street Journal has some solid analysis on how rewarding Greece will exacerbate rather than solve Europe’s fiscal problems:

…a bailout would, of course, end nothing. What it would do instead is open a wide new world of moral hazard—for Greece, for the countries providing aid, and for the future of the entire euro-zone. The Greek government has played the victim for all it’s worth over the past several months, insisting that the same credit markets that finance its extravagant spending were charging too much in interest. But on Thursday, following another upward revision to its budget deficit, bond yields soared and forced Mr. Papandreou’s capitulation. … a bailout comes with baleful consequences for the entire euro-zone. Further austerity demanded as a quid pro quo might take some domestic political heat off Mr. Papandreou, but the IMF’s policy history does not bode well for future economic growth. The EU countries expected to shell out €30 billion for Greece have their own debt challenges. If Greece is bailed out, the markets will rightly conclude that a line has been crossed, and that Portugal and even Spain will be rescued too. Even the Germans don’t have that much money. …Mr. Schäuble is so worried about Berlin’s finances that he opposes tax cuts for Germans, but he nonetheless wants to bail out a spendthrift Greece. …Greece represents only 2% of euro-zone GDP. While European banks would take losses on any Greek debt restructuring, those losses would not by themselves be catastrophic. But that wouldn’t be true if the sovereign debt panic spreads to Portugal and Spain. Far better for the EU to draw the line now, force Greece and its creditors to take their pain, and demonstrate to markets that there won’t be a rolling series of bailouts. To adapt Mr. Schäuble’s Lehman analogy, better to stop the moral hazard at Bear Stearns, lest Spain become Lehman Brothers.

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As usual, some very sound thoughts – on both the value-added tax and the income tax – from George Will:

When liberals advocate a value-added tax, conservatives should respond: Taxing consumption has merits, so we will consider it — after the 16th Amendment is repealed. A VAT will be rationalized as necessary to restore fiscal equilibrium. But without ending the income tax, a VAT would be just a gargantuan instrument for further subjugating Americans to government. …Because the income tax is not broadly based, it radiates moral hazard: Its incentives are for perverse behavior. The top 1% of earners provide 40% of that tax’s receipts; the top 5% provide 61%; the bottom 50% provide 3%. So the tax makes a substantial majority complacent about government’s growth. Increasingly, the income tax is codified envy. A VAT is the political class’s recourse when the resources of the minority that is targeted by the envious are insufficient to finance ravenous government.

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As I noted a few days ago, Paulson’s bailout was the worst possible way to do a bad thing. To the extent that the government had to inject money into the financial system, I explained, it would have been far better to use the “FDIC Resolution” approach, which at least addresses the moral hazard issue by wiping out shareholders and getting rid of incompetent management. Paul Volcker made the same point in yesterday’s New York Times:

The phrase “too big to fail” has entered into our everyday vocabulary. It carries the implication that really large, complex and highly interconnected financial institutions can count on public support at critical times. The sense of public outrage over seemingly unfair treatment is palpable. Beyond the emotion, the result is to provide those institutions with a competitive advantage in their financing, in their size and in their ability to take and absorb risks. …To meet the possibility that failure of such institutions may nonetheless threaten the system, the reform proposals of the Obama administration and other governments point to the need for a new “resolution authority.” Specifically, the appropriately designated agency should be authorized to intervene in the event that a systemically critical capital market institution is on the brink of failure. The agency would assume control for the sole purpose of arranging an orderly liquidation or merger. Limited funds would be made available to maintain continuity of operations while preparing for the demise of the organization. To help facilitate that process, the concept of a “living will” has been set forth by a number of governments. Stockholders and management would not be protected. Creditors would be at risk, and would suffer to the extent that the ultimate liquidation value of the firm would fall short of its debts. To put it simply, in no sense would these capital market institutions be deemed “too big to fail.” What they would be free to do is to innovate, to trade, to speculate, to manage private pools of capital — and as ordinary businesses in a capitalist economy, to fail.

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Kudos to Nicki Kurokawa, a former Cato employee, for this short but substantive video explaining “moral hazard.” She notes that government-subsidized risk played a pernicious role in the housing bubble and financial crisis, and warns that “too big to fail” may create similar problems in the future.

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