On Nov 28, 2007 11:32 AM, Michael Nuwer <[EMAIL PROTECTED]> wrote: > raghu wrote: > > Isn't moral hazard just econospeak for a familiar phenomenon: socialized > > risk and privatized profit? > > -raghu. > > Stiglitz sees moral hazard an any actions by parties to an agreement that are > short of due care. In his hands, any incentive problem is a moral hazard > problem. > > Could you please expand on what you mean by socializing risk? >
In a typical situation involving moral hazard in financial markets, a participant enters into a high stakes contract and assumes obligations that he does not intend to honor. Usually this takes the form of gambling using money borrowed without collateral (or more typically inflated collateral) - think Citibank's SIVs. Obviously such a scheme will not work without a fool who will act as counter-party i.e. in effect lend money without collateral. It turns out that such "fools" exist usually in the form of public institutions where (1) the money being lent is Other People's Money (OPM), and (2) the 'OP' are too small and too unsavvy to prevent this (Stiglitz' incentive problem?). The major examples are pension funds with employees money and government Treasuries with tax-payer money. Since the risk of loss is borne by these public institutions, we can say in effect that the risk is socialized. Of course this is by no means confined to financial markets. Other examples are say an oil company getting subsidies for exploration or a pharma company using public funds for R&D but retaining the IP. However, like so many other dysfunctions of capitalism, this also finds its purest form in the financial markets. -raghu.
