The Hazard of Moral Hazard

For over a year now, but especially since Lehman Brothers was allowed to go under, we've been trying to emphasize the idea that there may be nothing more hazardous to our nation's economic well-being than the notion of moral hazard.

Monday night Jim lambasted the rich east-coast elites who say we have to let General Motors and Ford fail, in part because of moral hazard, the idea that by bailing companies out, the government encourages other businesses to be more reckless because they believe they, too, can be bailed out.

But from the very beginning of the credit crisis, when people still thought this was only a subprime problem and Jim was screaming for the Fed to cut rates, people used moral hazard as an argument against those rate cuts: We can't cut rates because the bankers and the hedge funds were irresponsible and have to be punished for it. Or they'll never learn, as though the losses they'd already taken weren't punishment enough.

This concept of moral hazard is the reason the government let Lehman Brothers go bankrupt. The policy makers clearly had no idea how much damage would be caused by letting an institution like Lehman fail, but they did believe that letting Lehman fail would encourage other companies not to put themselves in a position where they'll likely go bankrupt. As if they needed any encouragement! Nobody running a business thinks, "Well, we'll either be really successful, or we'll fail utterly but that's OK because the government will save us."

Getting a government bailout, like AIG got, may be a better alternative than going under like Lehman, but no matter how many bailouts the feds do, no management team will want to go down the road of AIG. We're not denying the conceptual validity of moral hazard, but at the level of big corporations, the moral hazard argument just doesn't stack up well against the "we don't want double-digit unemployment and a return to the Great Depression" argument.

We have been on a crusade against the mean-spirited deployment of moral hazard as an argument for letting companies fail, this idea that it's better to destroy the economy so that businesses and workers know not to be lazy or make bad decisions, than it is to help and avoid total catastrophe. So when you hear somebody saying we can't bail out the autos because of the moral hazard problem that would create, always remember to compare the size of the moral hazard problem with the magnitude of the material problems that would be created by not bailing out the industry.

Cliff Mason is the Senior Writer of CNBC's Mad Money w/Jim Cramer, and has been that program's primary writer, in cooperation with and under the supervision of Jim Cramer, since he began at CNBC as an intern during the summer of 2005. Mason was the author of a column at during 2007, which he describes as "hilarious, if short-lived." He graduated from Harvard College in 2007. It was at Harvard that Mason learned to multi-task, mastering the art of seeming to pay attention to professors while writing scripts for Mad Money. Mason has co-written two books with Jim Cramer: Jim Cramer's Mad Money: Watch TV, Get Richand Stay Mad For Life: Get Rich, Stay Rich (Make Your Kids Even Richer). He is 100% responsible for any parts of either book that you did not like.

Mason has also had a fruitful relationship with Jim Cramer as his nephew for the last 23 years and will hopefully continue to hold that position for many more as long as he doesn't do anything to get himself kicked out of the family.

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