Moral Hazard Economy
On Thursday, the Fed boss, who once worked in private equity, announced another $2.3tn worth of support for capital markets. The US central bank will offer to buy or backstop securities that would have seemed wildly inappropriate a month ago. The package includes so-called “fallen angel” junk bonds, junk bond ETFs, municipal debt and an array of asset-backed securities.
Moral hazard is the risk that a party has not entered into a contract in good faith or has provided misleading information about its assets, liabilities, or credit capacity. In addition, moral hazard also may mean a party has an incentive to take unusual risks in a desperate attempt to earn a profit before the contract settles. Moral hazards can be present at any time two parties come into agreement with one another. Each party in a contract may have the opportunity to gain from acting contrary to the principles laid out by the agreement.
By JM Hamilton (4-20-2020)
How exactly did moral hazard come to be the defining feature of the US economy?
First, what is moral hazard? Moral hazard is when a party enters into a contract in bad faith. A classic example would be when someone enters into a bank loan, fraudulently, w/ zero intent to pay back the loan. In insurance, the oft-used example is when a house is already on fire, and the owner calls up an insurance carrier looking for coverage or additional coverage, perhaps a second property policy? A close cousin of moral hazard, if not a synonym, is bad faith or in street vernacular, a scam.
Banks and insurance companies avoid moral hazard like… well, the plague. And yet, banks and insurance carriers support, directly and indirectly, the very definition of moral hazard on a daily basis, the private equity model (PE). The private equity model buys up businesses using catastrophic debt/leverage, w/ other people’s money: front loads profit; declares themselves unearned dividends; charges outrageous management fees, often for running companies into the ground; lobbies for and has obtained preferential tax treatment; is known to take out swaps and derivative bets against the very third party debt used to support its efforts; and either flips or liquidates the business at the end of a five year investment period. And that’s just scratching the surface.
PE LBOs are done under the oft-cited premise that they are here to improve or rescue a business, but, as is often the case, they end up burying the business, along w/ jobs & opportunity.
The private equity loot & pillage model defines moral hazard. PE makes money eight ways to Sunday, faster than a person can say, “leveraged buyout.” At a micro-level, PE makes money on a one-off deal, and it generally, cares less if the bondholders, the business, and the employees survive or not… because there’s always another set of investors who are starved for bond yield thanks to the FED. At a macro-level, this entire industry has become so pervasive that the PE model has been adopted by both public and private companies, only it goes under the nom de guerre financial engineering.
Companies that are leveraged up (be they private or public), so as to reward management & ownership interests in a rather piggish manner… have done the company, local businesses (suppliers), and labor a serious disservice because these enterprises are ill prepared for crisis. At a macro level, entire business sectors – concentrated – and leveraged to the hilt – have set themselves up for ruin and are unable to fend off any exogenous & endogenous shock that comes along. The virus – an entirely foreseeable event - has brought the private equity model into clear view, for what it is: not capitalism but organized crime.
How can this be? Afterall, if an individual commits insurance fraud or enters into a loan with a bank, via bad faith, surely, they’ll be prosecuted to the Nth degree by said financial institution. Rightfully so.
One of the ways that private equity, as an industry, or say, the airlines, is able to accomplish this is through scale. If an individual steals from a business or a set of investors, it’s a crime. When an entire industry, or a too big to fail (TBTF) monopoly, engages in what is tantamount to theft from other businesses, bondholders, the US economy, labor, or the American taxpayer…. well, that’s grounds for a congressional and federal reserve bailout. Not only do TBTF companies and industries engage in moral hazard at a macro and micro-level, but they also buyoff and lobby the US congress for preferential treatment. It’s as if a drug cartel has purchased the executive, judicial and legislative branches of the US government. Mission accomplished, democracy subverted. And since the neoliberal economy – the anything goes economy – produces so few jobs, these highly leveraged industries are able to hold up the prospect of losing jobs, and investor harm (such as pension funds), as a means to extort bailouts from congress… or at least provide congress - which is in on the scam - w/ a convenient reason to bailout said industry.
In short, the taxpayer bails out avaricious management teams, setting the precedent for a continuous loot & pillage cycle; the taxpayer bails out these crime lords, when the money is desperately needed for a Green New Deal, Medicare for All, or student debt forgiveness.
Capitalism used to mean the risk takers were rewarded for good business practices and suffered losses for egregious business conduct that was detrimental to the company and the public at large… under the moral hazard economy, financial engineering and private equity are rewarded no matter how badly they fail and no matter how adverse their behavior is to the American economy and public.
Moral hazard as the defining feature of the economy didn’t happen in a vacuum. Financial engineering, moral hazard, and private equity didn’t just flourish on their own. No, these businesses and business practices had to be nurtured and created under the right set of circumstances, engineered in a highly controlled environment… not unlike a virus.
W/out the FED engaged in highly accommodative monetary policy and suppressing interest rates - and essentially providing free money to a predatory financial elite - the private equity model couldn’t exist or certainly wouldn’t be as profitable. (Those extraordinary profits, in turn, could not be used to perform an LBO on the US congress.)
Why does the FED do it… why does it engage in exceptionally easy money polices? Well, one, we have catastrophic national debt, much of it derived bailing out banks from the 2008 and the current crisis and financing endless war. Two, the private sector – engaged in moral hazard (see this article) – is in debt up to its eyeballs. And three, banks and insurance companies sell hundreds of trillions (notional value) in derivates and swaps, much of it insuring & speculating on all this debt. These swaps and derivative products are essentially the financial gun held to the FED’s head, that ensures the whole rigged process – of enriching the predatory few, at the expense of hundreds of millions of Americans – continues infinitum.
The final reason ultra-accommodative monetary policy continues, the FED is accountable to no one (certainly not the American people), but rather, to the congress of the United States, which we all know by now has turned abdicating its responsibilities into an art form. And given all the insider stock trading conducted by the American legislative branch, and the fact that the FED lets the house and senate members off the hook from doing its job – by monetizing the national debt - the congress has zero interest in reining the FED in.
Now, w/ the coronavirus crisis at hand, the FED has ramped up moral hazard to a whole new level. With money flowing out of the stock & high yield debt markets (because the American consumer, the driver of the economy – in most instances - is now tapped out & unemployed), and those highly leveraged balance sheet increasingly look like a noose for piggish management teams… The FED has printed up $4.0 trillion to backstop various debt and stock markets. The FED backstop, or bailout, is for the personal enrichment of a privileged few: bondholders, failed management teams, & shareholders, specifically. Notice, the FED is not bailing out American labor… there’s no UBI, and there is no infrastructure program. There is a $1200 check, maybe, and a supplement for unemployment benefits through the end of July. Gig workers … the majority appear to be on their own.
The FED, like an arsonist, is essentially throwing $4.0 trillion in jet fuel onto the burning inferno that is the moral hazard economy: doubling down, if you will, on the US caste system, the death of the American Dream, near zero social mobility, and catastrophic wage & wealth inequality. In doing so, like private equity, the FED has mortgaged – to the hilt – future generations’ and the nation’s future.
The lie that these management teams & ownership did nothing to create the circumstances of their own immolation, must come from some alternative Bizarro Universe. Private equity and moral hazard are both receiving an exceptional bailout with the FED buying up JUNK DEBT…. hundreds of billions of it. The FED is also issuing loans to overleveraged industries and corporations. Moreover, per the Washington Post, it appears that the FED and Treasury may agree not to name which companies are on the public dole. Once again, backstopping bad faith, moral hazard, and theft; and confirming, once again, all great crimes happen under cover of night, or cover provided by an opaque government. Thanks to the FED, we see that profits are privatized, while losses are transferred from the private sector and placed upon the FED’s balance sheet… the American people’s balance sheet. As for the overpaid management – that set these companies and industries ablaze – they face zero hardship: not job loss, not nationalization, not even public shares w/in their companies, and they can return to biz as usual (once their public debts are paid, if not sooner). Who knows? Thanks to congress… this is the largest, most opaque, bailout this country has ever seen.
Thanks to the FED's machinations and a flat yield curve, investors and pension funds – starved for returns – are conveniently herded into a stock market, w/ astronomical - highly speculative/suspect - valuations. A stock market that has no basis in reality and a very poor foundation, in terms of business fundamentals. Don’t like the stock market? Well there’s always alternative investments, w/ the arsonists over at private equity. How convenient. (The analogy that financial engineering & private equity were created, & nurtured, like some rogue bioweapon or virus, in some mad banker’s lab holds.)
Moral hazard affirmed by the US congress and the FED once again. The preeminence of the rigged economy, oligarchy, and the private equity model, supported w/ trillions in debt, courtesy of the FED and a complicit congress: confirmed. The American people, on the other hand, will be facing: an economy that will struggle for many months, if not years, to recover lost ground; diminished benefit & wage prospects, accompanied by possible deflation; zero bound interest returns on their savings; and almost certainly, endless austerity from the federal government.
How do we end the cycle of catastrophic theft, welfare for plutocrats, and ceaseless austerity for the American people? Easy, remove any of the excuses the FED has for ultra-accommodative monetary policy: one, write down the national debt, much of it generated bailing out & enriching so-called expert bondholders, management teams, and shareholders; two, democratize the FED; three, limit campaign contributions to public money, only; four, cap the leverage ratio on all businesses, private equity owned or otherwise; and finally, five, outlaw all speculative derivatives and swaps.
By enacting these measures, the moral hazard economy maybe far less exciting… but excitement in times of ever increasing economic & financial crises is overrated. So is a highly corrupt government and its ownership, oligarchy, backstopped by an unaccountable/undemocratic Federal Reserve.
Copyright JM Hamilton Publishing 2020
No comments:
Post a Comment