In the aftermath of the recent sub-prime crisis we are witnessing a definitive trend in governments stepping in to guarantee and even bail out failing financial institutions. This trend threatens to encourage a climate of moral hazard in lending practices, and carries the seeds for more such disasters in future. Armed with the virtual guarantee arising from a growing impression that the government cannot afford to let their large institutions fail, the already cavalier fund managers will now have the final stamp of authority for reckless lending.
The latest example is the problems facing the giant mortgage finance firms, Fannie Mae and Freddie Mac. With the crisis deepening, the Bush administration yesterday asked Congress to approve a sweeping rescue package that would give officials the power to inject billions of federal dollars into the beleaguered companies through investments and loans. The Fed announced extension of its short term lending facilties (discount window) to these two firms, so as "to promote the availability of home mortgage credit during a period of stress in financial markets."
Another example of such moral hazard is in the sector of education loans. As commercial banks concluded that the business of lending to college students was no longer quite so profitable, the Bush administration promised in May to buy their federally guaranteed student loans, giving the banks capital to continue lending.
Ironically enough, in the bastion of free market and free enterprise and in a sector (financial markets) considered most unfettered and unregulated, these trends have had the effect of bringing back big government into the public realm. The government is now fast becoming the lender of last resort to failing lenders, the numbers of whom are rising fast. The moral hazard unleashed by the actions of the US Government will take some rolling back!
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