Roundtable Discussion

Background Discussions:

Banking Crisis
Banking Crisis Over?
Economic Scenario Planning

Background Reading:

WSJ Articles on Debit Limit issue and Potential Default
History of the Debt Ceiling

Is Moral Hazard a Moral Hazard?

Moral hazard is a phrase used to describe allowing bad behavior in the financial markets. For example: in capitalism the free market is thought to self-correct greed and fear by the “invisible hand“. But if government or regulators bail-out bad actors, they can be perceived to allow bad behavior, such as greedy investing. A classic example of this was back in the financial crisis when Lehman Brothers was allowed to fail after the regulators bailed out Bear Stearns earlier that year through a forced sale to JPM.

The idea has merit on the surface – set an example by allowing bad actors to “fail”, that way others will think twice before thinking being so greedy. The problem is, it is hypocrisy if the “pot calls the kettle black” which is to say, if market participants punish the greediest, but applaud their slightly less greedy investment structures, that is nothing but hypocrisy

All of us have become like one who is unclean, and all our righteous acts are like filthy rags; we all shrivel up like a leaf, and like the wind our sins sweep us away

Isaiah 64:6

Hank Paulson during the financial crisis of 2008 was faced with these and many other dilemmas. The day after they allowed Lehman to fail, they had to bail out AIG, which was a far worse problem. WAMU failed. Other banks and financial institutions failed. The cost of attempting to let Lehman fail in the name of moral hazard was TARP and massive, broad based bailing out of the financial system to rebuild confidence.

Other examples of moral hazard arguments are made about Student Loan forgiveness. This is a strange one, because the bible says to forgive all debts every seven years. But many Christians are decrying the government forgiving student loans by saying “what about all the responsible people who didn’t go into debt?”. However, we have to be careful not to embrace envy: “hey, how come they got free money and I didn’t?” At the same time, the only way we can forgive federal student debt is to pay it off with general federal debt. So, its not forgiving debt so much as it is shifting debt. An argument can be made this is better, but… This is our reality right now. We are faced with just a series of bad choices.

Speaker McCarthy’s Dilemma

The Republicans hold a narrow margin in the house right now. Speaker McCarthy’s election is on even thinner ice. Because a block of ultra-conservatives (House Freedom Caucus) put him over the top earlier this year, they also now have a gun held to his political head saying in essence: “if you don’t get the Democrats to agree to spending cuts, we will vote you out”. Back to Moral Hazard, the argument made by such financial hawks are: “if we don’t starting cutting our spending, we are going to go bankrupt as a country”. However, if the US government runs out of money through these negotiations, it may imperil our ability to continue to borrow money as a country. If that happens, the USD could partially fail and be relegated to just another currency. In other words, we risk losing being the world’s reserve and settlement currency. Many dominos could fall.

So is the debit limit brinksmanship liken to letting Lehman fail? Time will tell…

Chicken or Egg?

The last time the nation faced the debit ceiling crisis and not being able to service its debt was back in 2011 and 2013. We have a window into the discussions that were held then. Ben Bernanke explained that the first cuts would come to other government services, not principal and interest payments on the debt. Is that still the case? We will find out. What then will get cut? Social Security would be a political smartbomb. What else could get cut. Would that then create a partial government shutdown? Will the June 15th tax receipts be enough to limp through?

Banking Math

M2 money supply roughly $21Tn

Paper currency and coin in circulation $2Tn.

Bank Leverage is at least 10:1 – meaning $9 is lent out and $1 is held in reserve out of $10 of deposits

Bank reserves roughly $3.2Tn currently

Question: If we had a run on the banks and the financial markets (people pulling out hard cash from banks and money market (read short term bonds), would there be enough currency on hand to satisfy a run? If there is not enough, what then will the regulators do?

We can look to Cyrus and Greece as to how this was handled there in recent times…