"moral hazard", unwise risks, spiralling deficits

Ignoring Reality Has a Price

Excerpts:

... today’s ever-expanding bailouts do create some dangers. You’ve probably heard the term moral hazard, which is shorthand for the idea that government rescues may lead investors to take new, unwise risks — and ultimately require yet more rescues.

The Fed is also setting itself up for tough decisions about when to end its various emergency programs. If it waits too long, it could leave so much money sloshing around the economy that inflation will take off. Fed officials have suggested they understand that they made precisely this mistake after the 2001 recession, when they kept interest rates low and added to the mania in the housing market.

Finally, there is the net cost of the bailouts, which may well be bigger than Mr. Bernanke has acknowledged. Under the new program announced Tuesday, the Fed will own the commercial paper that serves as short-term loans for companies. If some of those companies go bankrupt, the Fed could suffer some losses.

The Treasury’s $700 billion bailout fund, meanwhile, is based on the premise that investors are collectively undervaluing assets and that the government can pay above current market prices without losing much money. “One has to be at least a bit skeptical,” the economist Greg Mankiw says, “about the idea that government policy makers gambling with other people’s money are better at judging the value of complex financial instruments than are private investors gambling with their own.”

After talking with budget analysts, I think it’s reasonable to assume that the bailouts will end up costing several hundred billion dollars, spread over several years. Perhaps $100 billion of that cost may come next year. Add in another $100 billion or so for the weakening economy — specifically the fall in tax revenue, increases in spending on social programs and the possibility of another stimulus package.

Even before the crisis, the Bush administration was set to bequeath a $550 billion deficit to its successor. Now, a better estimate appears to be $750 billion — or 5 percent of gross domestic product. The only years since the 1960s that the deficit has been nearly so large were the early 1990s (almost 4.5 percent of G.D.P.) and the mid-1980s (with a peak of 6 percent in 1983).

Obviously, next year’s deficit is a problem. And if you assume the credit crisis isn’t about to lift — which seems smart at this point — the ultimate cost of the bailouts could conceivably go higher. Whatever the final figure, it should still be put in some context.

Despite everything, the biggest fiscal problem remains, far and away, health care. Based on the rate that medical spending has been rising, the Congressional Budget Office forecasts that Medicare and Medicaid will take up 10 percent of G.D.P. within two decades, up from about 4 percent now. In today’s terms, that would be the equivalent of adding at least $900 billion to the deficit every single year, in perpetuity. It makes the cost of the bailouts look like a rounding error.

Comment: I talked to my 88 year old Mother last night. I asked her about "the depression". Her Mother was a schoolteacher and worked without pay. Her Dad ran a Standard Oil rural distribution route (HQ in Alto Michigan). His customers bought on credit and were persistently behind in payments. They survived and we will too!

But politicians have over-promised and we must not rely upon government for every need!