Moral Hazard and the Financial Crisis

There is no denying that the current financial crisis has delivered a major seismic shock to the policy landscape. In country after coun-try, we see governments panicked into knee-jerk responses and throwing their policy manuals overboard: bailouts and nationaliza-tions on an unprecedented scale, fiscal prudence thrown to the winds, and the return of no-holds-barred Keynesianism. Lurid sto-ries of the excesses of “free ” competition—of greedy bankers walk-ing away with hundreds of millions whilst taxpayers bail their institutions out, of competitive pressure to pay stratospheric bonus-es and the like—are grist to the mill of those who tell us that “free markets have failed ” and that what we need now is bigger govern-ment. To quote just one writer out of many others saying much the same, “the pendulum will swing—and should swing—towards an enhanced role for government in saving the market system from its excesses and inadequacies ” (Summers 2008). Free markets have been tried and failed, so the argument goes, now we need more reg-ulation and more active macroeconomic management.1