Remember the controversies over the State Children’s Health Insurance Program (SCHIP) last fall? The Bush Administration was very concerned that spending an additional $30 billion over the next five years to cover more children would put the country on the road to “socialized medicine.” Even if economic reports indicated that only one in five families in the coverage expansion would drop private insurance to purchase government sponsored insurance, that was seen as far too high a cost to pay to allow even a bit more publicly-financed insurance to “pollute” children’s health care.
Yet the administration has recently endorsed the Fed’s $30 billion guarantee for JP Morgan as it purchases Bear Sterns. I’ll let the accountants figure out exactly how much of that money will end up being provided by taxpayers, but I think it’s safe to assume that more guarantees like this are coming, and that the market itself priced it in in response to the toxic subprime securities Bear still counts as “assets.”
So what are the practical consequences when a country allows millions of kids to go uninsured, but structures financial regulation so that leaders of banking firms face nearly no downside, and high upside, on extraordinarily risky investment strategies? It appears that we only worry about moral hazard in the health care arena (where it has been largely discredited), and not in the financial world (where it has been amply confirmed). Internationally, the US is looking less like a leader in financial innovation and more like a haven for crony capitalism. The New York Times describes the situation as “socialized compensation” for the connected:
Bankers operate under a system that provides stellar rewards when the investment strategies do well yet puts a floor on their losses when they go bad. They might have to forgo a bonus if investments turn sour. They might even be fired. Their equity might become worthless — or not, if the Fed feels it must step in. But as a rule, they won’t have to return the money they made in the good days when they were making all the crazy bets that eventually took their banks down.
The costs of such a lopsided system of incentives are by now clear. Better regulation of mortgage markets would help avoid repeating current excesses. But more fundamental correctives are needed to curb financiers’ appetite for walking a tightrope. Some economists have suggested making their remuneration contingent on the performance of their investments over several years — releasing their compensation gradually.
In a recent hearing questioning the extraordinary gains at top financial firms (for pioneering strategies that now may lead to massive government bailouts), Henry Waxman suggested that current policies may lead to a crisis of faith in the market system: