Banking on Bailouts

John Plender looks at the concept of “moral hazard” — the idea that providing a safety net for the banking system during times of financial crisis will only encourage more risk taking later on. The concept seems fairly sound, but the way it works on financial markets is more complex than people imagine, he writes. “Because so many holders of bank liabilities expect to be bailed out, they do not do enough homework on risk. That lack of discipline is then compounded by excessive reliance on all too fallible rating agencies. And because creditors underprice the risk taking of institutions that are too big or too interconnected to fail, systemically important outfits enjoy a lower cost of funds than they should.”