W°E HAVE heard a lot about moral hazard over the last three years. The concept is a simple one. If people do not believe they will be fully responsible for the consequences of their actions, they are likely to take bigger and more foolish risks. The concept cropped up as a central issue in the response by governments across the world to the banking crisis and the related economic slump. In general, it has been more honoured in the breach than the observance as country after country pumped billions into banks and other organisations that were fundamentally the architects of their own destruction through foolish - indeed extraordinary - risk-taking.
This week the head of regulation at the Central Bank Matthew Elderfield raised the issue of moral hazard as he outlined his thoughts on the problem of borrowers falling behind on their mortgages. Although Mr Elderfield seemed to recognise the scale of the difficulty, which he described as the biggest legacy of the financial crisis, he appeared to set his face against any bailout for the 32,000-plus borrowers who can no longer meet the mortgage repayments on their homes.
It should be borne in mind, Mr Elderfield argues, that it will be the more thrifty and prudent neigbours of these people who will bear the cost of any bailout. The implications of all this in terms of moral hazard are obvious. But equally obvious is that the euro zone’s €750 billion bailout plan for member states amounts to little more than prudent countries bailing out their feckless neigbours, ourselves included. The scale is greater but the parallels are clear. Ireland may avoid being a direct beneficiary of the plan currently being contemplated, but to pretend its existence does not underpin our national solvency is facile.
The concept of moral hazard went out the window after the collapse of Lehman Brothers and simply has no currency in the debate about how best to face the fact that a significant portion of the Irish population is over-borrowed and saddled with debts they will struggle to pay. Removing the issue of moral hazard is not the same as advocating that people should be allowed escape their debts, but it does ensure this important debate takes place in an intellectually honest fashion.
The real question is what is in the best long-term interest of the State and its citizens as this is the metric by which the decision to pump €32 billion into our banks was made, not moral hazard. It is about more than the balance sheets of banks, which is Mr Elderfield’s primary concern.
A working group - of which Mr Elderfield is a member - is due to report to Government shortly on this and related issues such as negative equity. The choice appears to lie between allowing the banks deal with problems on a customer by customer basis – and hopefully in a humane fashion – or some form of State intervention, which would involve taxpayers’ money being used to facilitate individuals restructuring their debts. Both have their drawbacks and the problem is incredibly complex. But it is one that must be faced honestly.