I just think it's interesting that the worries about "moral hazard" are so completely different on different sides of the Atlantic.
Over here, we worry that bailing out the creditors (who were owed tons of money that wasn't repayed) because they were too big to fail is a moral hazard. They don't have the proper incentive to minimize their risk knowing that they have free insurance courtesy of Uncle Sam.
Over there, they worry that bailing out the debtors (who owe tons of money that they can't repay) because they are too big to fail is a moral hazard. They don't have the proper incentive to not borrow so much money knowing that their tab is going to be picked up by Germany.
When governments make a bad loan go away it presents a moral hazard in both directions. When someone picks up the drunks tab for him, the bartender doesn't have to pay the price of his bad decisions (in letting this guy have a tab) as well. There doesn't seem to be enough talk about the moral hazard of bailing out Greece or Portugal or Spain or Italy as it concerns the creditors. The European banking system let not very creditworthy countries go deeper and deeper into debt they couldn't or wouldn't repay.
The Eurozone got into this crisis because spreads between debt in the strong core (Germany) and the weak periphery (Portugal, Italy, Greece, and Spain), were too low. Not only that, European sovereign debt was allowed to be used as "core capital", essentially risk free, when it wasn't. There was the assumption that if worse came to worse they would be bailed out. And whadya know.
Right now, we have a situation in which efforts to rescue the euro are being held up over concerns that not forcing these profligate governments to pay their debts themselves, there won't be the proper incentive to run a responsible budget. But at the same time, we're not going to let their banks, where their citizens keep all their money, take substantial losses and probably go bust. And face the proper incentive to not make such poor investments in the future.
So, the CDU/CSU coalition that runs Germany, has decided to play brinksmanship, and insist on harsh austerity measures partly to make these countries feel the pain of their bad decisions. But there is always the assumption that Germans who put their money in the hands of idiotic bankers are not at risk of loosing their money for their bad decisions.
They assumed that countries would be honor bound to pay of their tab, when that's not how the world works. Countries often default on their commitments. And so, Angela Merkel intends to force them to pony up. She has decided to allow bankers to claw their money back by essentially threatening to break the drunk's legs if he doesn't settle his tab. But private creditors shouldn't get to count on support from their government to avoid suffering losses, unless we want to make gunboat diplomacy a regular feature of international finance.
The way to avoid moral hazard is to let people go into bankruptcy and then sort it out there. But we're not going to do that right now because then the world would end. We can at least learn something, though.
It seems that everyone acknowledges that the Greek government behaved atrociously in going so deeply into debt. And after they get bailed out, we're going to make sure they don't do it again. But people still haven't acknowledged that German and French bankers behaved atrociously in assuming that they could money lending money to Greece but not accept any risk. And after Greece gets bailed out, we need to make sure they aren't going to do it again. And from now on we're going to remember that countries default, it happens. But lets just admit that large scale government intervention to save the euro will leave the integrity of the market deeply compromised in many different ways, and presents many different moral hazards.
If the German government is going to monitor Greece's budget, lets have Greek banks monitor German banks. Or we could just stop worrying about whose fault this all is and just fix it, instead of trying to decide whose fault this all is right now.
