Insured Lives Sometimes Commit Suicide

Moral hazard is a term with specific meaning in the financial community.

Originally the phrase was mainly used to describe a phenomenon within the insurance industry related to the uncertainty about the honesty of those insured.

Premium writers have at times noticed that a few who buy insurance lose any incentive to minimize risk, correctly thinking this has been laid off on the company writing their policy.

Insured lives sometimes commit suicide but leave no notes. Warehouses burn down more often when filled with hard-to-sell inventory.
Auto owners sometimes fail to lock their cars if they are behind on their lease payments. Expensive jewelry gets misplaced when its holders come under financial pressure.

This phrase now is more often used to describe components of systemic financial system risk that have sprung up in the financial crisis that began in 2008.

The odd marriage of Wall Street and government has produced two enormous moral hazards: the securitized mortgage, as well as its cousin, the credit default swap, which together brought down the financial system in 2008.

It has begotten conflicted market structures, such as the government mortgage agencies that promote home ownership through weakening standards, but at the same time implicitly guarantee these loans.

Large brokerage firms and banks fearlessly extended credit knowing they had the Federal Reserve standing by to slash the cost of funds and repair their balance sheets.

Depositors readily handed over their savings to them, because the FDIC guaranteed against loss. Other strange beasts have evolved over time: Ratings agencies are paid handsomely by issuers, particularly for high margin, complex derivative securities.

For years many feared a conflict between commercial banking and brokerage, but this separation was irrelevant in the current crisis, as proven by the better performance of institutions in Canada and other countries.

No one objects that investment banks give away purportedly objective research that happens to compliment high-margin corporate finance activity and proprietary trading operations, a structural flaw that damages the competitiveness of those who would author reports on investments with an independent perspective.

While these financial hazards have gained attention, the largest by far gets no recognition at all.

The operation of a fiat currency encourages the accumulation of debt, which in turn pumps up the value of assets including stocks.

After generations so much can be amassed that a mega – collapse can ensue, one far greater than if gold backed the currency and also bank reserves. Gold acts as a brake on reckless expansion because the threat of conversion of paper back to gold is always a possibility.

In fact it is likely whenever pyramiding of national currencies or bank loans is uncomfortably high.

The danger of fiat currency is invisible to the public, professional investors, and political commentators, who are oblivious of its mechanism.

Thought to be a “normal” element of finance ever since we moved off direct specie systems shortly after the Constitution was ratified, its inherent flaw has remained concealed despite the meltdown of the financial system in 2008.

Since it is likely to remain unknown, it provides the ideal vector for transmitting the disease of socialism throughout the economic corpus.

The collapse of the economy permitted the majority – controlled Congress in conjunction with the new administration to authorize an unprecedented quantity of government spending, which will be funded in part by some $1 trillion of freshly minted fiat currency.

There can be no question that this is a seizure of wealth roughly equivalent to one year’s collection of income tax, yet there is more outcry over making a trivial increase in the topmost bracket from 35 percent to 39.6 percent.

The conditions for vulnerability to this virus are ideal, for the window for fiat money growth through bank loan expansion, which would normally accrue to the private sector, was closed once the public discovered it could no longer tolerate debt levels at over three times national income.

As the adage goes, when one door closes another opens; money creation can only be done now through fl at-out printing, and this solely flows through a pipeline directly into the U.S. Treasury.

The historical record is such that helicopter dumps of cash through the monetization of debt enliven an economy temporarily, like the flash of burning magnesium.

So it is likely that another downleg could follow, which would require repeated doses of the same inefficacious medicine.

The effect is to exhaust the wealth from savers and investors and dispense it to the lowest income brackets of society through entitlements such as expanded health care.
Thus, in addition to spreading socialism through changing the tax code, the new administration will be able to utilize the interlocking system of fiat currency and fiscal spending to redistribute far more wealth quickly than ever was collected and redirected by the IRS.

Commentators on Wall Street greeted the first salvo of the economic recovery strategy by cheering on a massive stock market rally that began in March 2009, while talk radio focused only on the spending and taxation angle of the stimulus, completely missing the point that none of this could have been accomplished without facilitation from the Fed.


Bill Baker,
for The Daily Reckoning

[Editor’s note: This passage is reprinted from William W. Baker’s book, Endless Money: The Moral Hazards of Socialism, with the permission of John Wiley & Sons, Inc (©2010). You can get your own copy here.]