Capitalism without losses is not capitalism

Economist Russ Roberts put forth the idea that the financial crisis was caused, in part, by moral hazard resulting from a history of taxpayer financed bank bailouts and the implicit taxpayer guarantees on mortgages that were manifested in  Fannie Mae and Freddie Mac.

Roberts’ white paper Gambling With Other People’s’ Money: How Perverted Incentives Caused the Financial Crisis was released last April.  This is from the Executive Summary of the white paper:

Over the last three decades, government policy has coddled creditors, reducing the risk they face from financing bad investments. Not surprisingly, this encouraged risky investments financed by borrowed money. The increasing use of debt mixed with housing policy, monetary policy, and tax policy crippled the housing market and the financial sector. Wall Street is not blameless in this debacle. It lobbied for the policy decisions that created the mess.

Roberts goes on to say that gambling with other people’s money is wrongly mistaken with capitalism and capitalism was then incorrectly blamed for the crisis.

I agree with Roberts, but I haven’t seen many who have shown outright support for his hypothesis.  It seems others believe the moral hazard link is tenuous at best.  However, now the Administration might agree, according to this Wall Street Journal editorial.  From the editorial:

The Administration puts the case for federal withdrawal from the broader housing market in compelling terms: “The strength of this option is that it would minimize distortions in capital allocation across sectors, reduce moral hazard in mortgage lending and drastically reduce direct taxpayer exposure to private lenders’ losses.”

I believe Roberts said it best when he said:

Capitalism is a profit and loss system.  Profits encourage risk-taking.  Losses encourage prudence.

If you reduce or limit the losses because you believe that helps someone (home buyers), you also reduce the prudence of the lenders and increase the risk-taking.  And you no longer have capitalism.

1 thought on “Capitalism without losses is not capitalism

  1. John B. Taylor is his book Getting Off Track (85 page book that can be read in one or two evenings) basically supports Robert’s point. Taylor said the Federal Reserve created a cheap money bubble that caused an environment for shenanigans (moral hazard). That is, with a cheap money bubble created, from Wall Street to main street, to the borrower, to mortgage loan originator, to the property appraiser….right down the line, the stage had been set for shenanigans. An incentive for shenanigans, if you will.


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