Thursday, December 3, 2015

Will this end moral hazard in banking?

The Fed ends "too big to fail" bailouts:
Under the new rule, banks that are going bankrupt -- or appear to be going bankrupt -- can no longer receive emergency funds from the Fed under any circumstances. 
If the rule had been in place during the financial crisis, it would have prevented the Fed from lending to insurance giant AIG (AIG) and Bear Stearns, Fed chair Janet Yellen points out.


  1. I think this is great news that the Fed has officially adopted a new rule that limits its ability to lend emergency funding to banks. In my opinion, I do not think that the government should save Wall Street Banks during a financial crisis.
    We (consumers) are not allowed to borrow money from a bank during our personal financial crisis, if we are unable to pay it back. Our applications are declined due to debt to income ratio is too high. Therefore, I think it is great that Banks are going to be held to the same standards as consumers. I do not think that we taxpayers should bail them out when they have made poor/bad decisions.
    Consequently, I think this is a great way to prevent future financial crisis. This new rule, allows the Fed to perform a stress test on banks to see how they perform in a mock financial crisis scenario. As a result, it will force some banks to increase their reserves just in case a crisis occurs.
    I am also looking forward to the Fed raising the rates, because I would like to start making so really money on my savings accounts.

  2. The article suggests that the new federal regulation will eliminate or limit the ability to authorize emergency loans to banks that are going into crisis. Is this likely or not? To begin, the banks often conducted riskier transactions due to the consequences of moral hazard. The United States Federal organizational regulations allowed this type of moral hazard by putting in a safety net that was not properly funded in the first place (lack of a fund to cover potential loss). By creating a safety net, the country allowed banks to engage in riskier behaviors with consumers. A balance must be met that protects the United States infrastructure but allows banks the ability to freely offer profit-seeking deals to allow markets to go from lower to higher value for both the consumer and lender. The tricky part of this deal is to decrease risk and to eliminate the moral hazard concept that the federal bank will bail out the banks in future shortcomings. In my opinion, the increased regulations will help to limit this moral hazard; however, it is unlikely to completely change the banks perspective due to institutional power in the marketplaces.

    During the financial crisis, the government bailed the banks out. It was important for the US to maintain a stable financial infrastructure as the major banks had such a grasp on the economy. It was shown that too many banks failing could create intense risk for the infrastructure of the financial sector. AS a result, the bank was almost forced to lend money. Since that time, the financial industry leaders have only gotten bigger. The current behemoths like JP Morgan Chase & Company, Bank of America, Citigroup, Well’s Fargo, U.S. Bancrop understand that they have much power if there organization grows as large as possible. If one of these or several of these organizations were in risk of failing in the future, the government or consumers likely would not allow several to fail as the unrelenting consequences on the financial sector.

    In order to limit the moral hazard (of getting too big or even bailing banks out), it would be ideal to create savvy opportunities for other financial institutions to form and supporting smaller local lenders to spread risk.

  3. In my opinion, I do not believe that this is the end of moral hazard in banking. Even though the Federal Reserve has stated that “big banks shouldn’t expect another bailout next time”, they will still allow emergency lending to banks as a last-resort option.” (Gillespie, 2015) The decision to help banks in trouble will be left to Federal judges which could be very difficult for them to decide.
    As long as there are loop-holes, or a “what’s behind door number 2” scenario, banks may “exercise less care because they have little incentive to do so” (Froeb, McCann, Shor, & Ward, 2014). The only way to put an end to moral hazard is to make the banks face consequences for making bad investments.
    Froeb, L., McCann, B., Shor, M., & Ward, M. (2014). Managerial Economics - A Problem Solving Approach (4th ed.). Boston: Cengage Learning.
    Gillespie, P. (2015, November 30). Fed ends 'too big to fail' lending to collapsing banks. Retrieved from CNN:

  4. Chapter 20, "the problem of moral hazard":

    While the environment and business theme of a private dental practice does not superficially match the colors of insurance companies as described in text and slides, there are similarities. The interview process and trial employment best tries to ferret the hidden information the applicant and new employee omitted from presenting in either the written application, the verbal discourse during the interviewing conversations with myself and senior staff, and possibly the interview and vetting process from the temporary personnel agency we use. Sometimes we think we found a winner, sometimes we know very soon we did not.

    Conversely, “only time will tell” is my grandmother’s phrase that proves succinct in the long run. Here are the tales of three dental assistants removed from the practice after the damage was done. Moral hazards and hidden actions discovered over varying periods of time.

    The first, a twenty year completely trusted dental assistant who breeched trust and professionalism to the highest level. She was discovered by several staff members to be inhaling nitrous oxide (“laughing gas”) initially off hours and eventually during working hours. The staff attempted to do “interventions” to no avail. They held off telling me. When I found out, a short straight forward “don’t do it anymore.” Ignoring the directive, caught red handed, in the act during patient time one morning, she was terminated on the spot. Given the choice to immediately write a letter of resignation or face charges (including calling the police), the letter was written in minutes, and out the back door she went. (She was also strongly suspected of taking opioid medication pills kept for patients, but only circumstantial evidence was ever found.) (Two months later, she attempted to illegally access the practice’s retirement accounts online and by telephone.) (employee “hidden actions”)

    Second, the replacement for the above “first” employee was a thirty year experienced and credentialed dental assistant. While never quite “fitting in” and abundant errors and mistakes every week, and complaints about the doctor and rest of the staff for problems, the final episode was quite stark. I discovered completely by accident that she (sometimes?) secretly disposed of the used dental needles by discarding them in the regular trash. (A major federal and NJDEP transgression)(I took digital photographs of the evidence) I didn’t have chance to get the personal satisfaction of dismissing her from the office. My office administrator took it as her responsibility to confront this employee and effectively initiated her (poorly composed) written resignation (emailed) from my employ the next following workday. (employee “hidden actions”)

    Third, the replacement for the above “second” employee was a temporary from the employment service. We used her on long term basis weekly from the agency. Perhaps again from my grandmother, “familiarity breeds complacency, breeds stupidity.” After several months of barely adequate performance, the employee’s attendance in the practice was compromised several times per week with excuses of her children had late start times for school and she would be late. And school was ending early so she had to leave early. Often the employee’s mother would call the office inquiring “where was she” (the grandmother was looking after the children). When my office administrator decided to investigate, she found the stories were fraudulent. The employee was having an affair (secretly?) and the lost time compromised the workflow of the office. Again, my office administrator shouldered the responsibility of terminating the employee. (employee “hidden actions”)

    To paraphrase the (Froeb, p. 260) text, with a bit of author interpretation, “when the values and value of the dental assistant falls, the risk of moral hazard increases.”
    Lee Lichtenstein

  5. We know markets make mistakes that is unavoidable in an innovative economy. Of course these mistakes cannot be allowed to bring down the entire economy down to its knees. Though those too big to fail banks were not the sole cause of the 2008 financial crisis, there is no question their presence at the center of our financial system contributed significantly to the magnitude of the crisis and to the extensive damage it inflicted across the economy.

    While significant progress has been made to strengthen the financial system such as forcing large firms to hold more capital, deeper resilient sources of liquidity, breaking up large banks into smaller less connected less important entities, taxing leverage throughout the financial system to reduce systemic risks wherever they lie, I believe the Act did not go far enough. Although considerable progress has been made, and these are steps in the right direction, the biggest banks, to me, are still too big to fail and continue to pose significant ongoing risk to our economy. A stress test check on whether the most systemically important institutions can withstand a serious shock to the economy, unfortunately came up with unfavorable results. This makes it a doubt that the moral hazard in banking will end.

  6. Will this end moral hazard in banking?
    This is a rule that should have been in place for a long time. This will restrict banks and keep them honest with the money they are lending. On top of this, banks should incorporate internal policies that monitor unethical conduct. As a business/corporation you need to have transparency. You need to have a clear vision that is seen by everyone in the company. You need to have strong values and ethical guidelines. From the top down, everyone needs to comply and demonstrate these values/codes of conduct. Some ways to develop an organizations code of conduct are:
    - Impose a simple list of prohibited behaviors or rules. This is an opportunity for an organization to encapsulate its ethical values and practices while simultaneously reinforcing key legal and regulatory obligations (Silverman, 2008, pg. 66).
    - “All persons associated with the organization must be held accountable to the code’s provisions. No one, from the board of directors on down, should be immune from the code’s provisions” (Silverman, 2008, pg. 66).
    Most Codes of conduct include such topics as:
    - Ethical principles
    - Insider trading
    - Conflicts of interest
    - Workplace practices
    - Government relations
    - Compliance with laws and regulations
    - Integrity in the marketplace
    - The role of the organization’s compliance and ethics programs
    - Reporting mechanism
    (Silverman, 2008, pg. 68)

    Silverman M. (2008). Compliance Management: for public, private, or nonprofit organization. New York. McGraw Hill

  7. Also, over the last 15 years we have witnessed so much. The government and large corporations need to have guidelines and they must be held accountable for their actions. We have seen too much negativity and fraudulent activities take place. Corporations need to have corporate social responsibilities (CSR). These are the actions of an organization that are targeted toward the achievement of a social benefit over and above maximizing profits for its shareholders while meeting all its legal obligations (Ghillyer, 2008, pg. 59). It’s important for organizations to go above and beyond making money. They need to give back to their employees, their community, etc. This is important for a company to excel and it promotes a positive brand image.
    Ethical CSR represents the purest or most legitimate type of CSR. Here, organizations can pursue and clearly define a sense of social consciences when it comes to managing their financial responsibility to its shareholders, what their legal responsibilities are to their local community and society as a whole (Ghillyer, 2008, pg. 67). Companies that follow these beliefs are managing beyond compliance. They are taking the next step and being a more responsible company.
    Ghillyer, A. (2008). Business Ethics: A Real World Approach (First Edition ed.). Boston, Massachusetts, United States of America: McGraw-Hill/Irwin.