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[Op-Ed] Rescue and Regulations

Posted September. 18, 2009 08:39,   


“The ones who come to an insurance company are sicker and the people have to pay more.” This argument appeared in an article in 1963 by Kenneth Arrow, who won the 1972 Nobel Prize in economics. In other words, those with cancer insurance policies smoke more frequently. Such moral hazard grows serious when others pay the premium. Arrow warned of such moral hazard 45 years ago. His nephew Lawrence Summers, director of the White House’s National Economic Council, is also worried over moral hazard. Summers taught U.S. President Barack Obama economics at Harvard University, and said those in charge of financial policies are significantly concerned over moral hazard.

A year has passed since the collapse of Lehman Brothers, but observers say “casino capitalism” has returned. When the global financial crisis rattled the economy last year, financial companies appeared to strive to become less reckless companies. They have, however, begun selling high-risk derivatives to earn a lot of money. High-ranking managers of Goldman Sachs earned 700,000 U.S. dollars over the past year, similar to their level before the crisis. Even President Obama has urged financial companies to accept the government’s strengthened regulations instead of rejecting them.

Both Obama and Summers seem to pretend not to recognize that the moral hazard on Wall Street resulted from their government bailout. Since the U.S. government played the role of a reliable insurer to help financial companies avoid staggering losses, such companies were able to reopen their casinos. That does not mean financial companies on Wall Street are particularly mean, however. Certainly, their Korean counterparts are no different. In 2007, the Seoul Metropolitan Rapid Transit Corp. recorded the largest deficit of 254.8 billion won (211 million dollars) among Korea’s state-run companies located outside of Seoul. The bonus the company’s president received last year, however, 556 percent larger than his salary. The heads of many provincial and municipal corporations also received exorbitant bonuses despite the burgeoning government deficit. This is the typical example of moral hazard in which leaders of state-run companies take benefits but pass on the burden.

If financial regulations are strengthened at the G20 Summit next week, will moral hazard at financial companies disappear? Financial historian Charles Kindleberger said government attempts to intervene in the market with the goal of beating the global economic crisis will worsen bubbles in the securities, housing and asset markets. That means moral hazard of market participants will grow more serious since they believe the government will bail them out via rescue or regulation. Kindleberger made the argument three decades ago but the world has not heeded his warning.

Editorial Writer Kim Sun-deok (yuri@donga.com)