Posts Tagged ‘moral hazard’

Unlimited Risks or Empty Gestures?

Wednesday, May 6th, 2009

In an earlier posting, I wrote of the complications of the Small Business Administration’s new loan program. New details have emerged that the risks may be greater than the public appreciates. SBA loans were the main topic at a recent town hall meeting at which President Obama noted that the annual volume of loans backed by the Small Business Administration was trending below $10 billion, down from $18.2 billion last year and $20.6 billion the year prior.

To stimulate the flow of credit to small businesses, the administration endorsed provisions in the stimulus bill. The legislation attempts to unblock the flow of credit to small businesses by temporarily raising government guarantees from 80% to 90% on the SBA’s flagship loan programs. In addition, it’s temporarily waiving SBA loan fees to reduce the cost of capital.

The Treasury now requires the 21 largest banks receiving funds under the Troubled Asset Relief Program to report their small business loan volumes on a monthly basis. Other banks receiving TARP funds must report this information quarterly. Treasury advised banks not participating in TARP that they too should make every effort to increase their small business lending. This push suggests that after the banks repay their TARP obligations, Treasury will continue to take an interest in SBA loans.

Critics of SBA programs charge that SBA loan guarantees create a moral hazard in incentivizing lending that’s harmful to U.S. taxpayers who must bear any losses. The most recent default rate reported on the SBA loan portfolio is 12%.

Further compounding the moral hazard risk is that some of the 21 largest banks have limited experience with small business lending. With the SBA principal guarantee on loans increased to 90% from 80%, taxpayers could potentially be underwriting a steep learning curve for the banks. Bank executives presumably appreciate how the public would likely assign blame for loan losses requiring additional taxpayer support.

This raises the question: is this a sincere effort to unblock the flow of credit to small businesses or an empty political gesture?


Moral Hazard in Disaster Relief Programs

Wednesday, October 1st, 2008
Wall Street

Wall Street

The current debate over the proposed legislation to authorize $700 billion for the U.S. Treasury to purchase non-performing mortgage assets raises a number of issues, including concerns about moral hazard risk. The draft legislation does not authorize the Secretary of the Treasury to oversee the recipient institutions from which the federal government would purchase these assets. Of course, banks could choose not to subject themselves to such oversight; they could simply refrain from participating in what is perceived as a bail out of Wall Street. But as the legislation stands right now, the Secretary of the Treasury would have no such authority, setting up a classic moral hazard risk. It is analogous to the federal government’s programs for disaster relief, which provide aid after the disaster has struck, but such aid is not contingent on land-use regulation or financed with risk-based premiums. As a result, construction in areas prone to major natural disasters has dramatically outpaced construction in safer areas. The management of risk is, in essence, the management of moral hazard and our federal government fails on that score.

At the same time, mega bank mergers (Citibank announced its acquisition of Wachovia, JP Morgan Chase has done the same for Washington Mutual and Bank of America is to be the new owner of Merrill Lynch) means that we have more banking institutions deemed too big to fail.  The insurance industry, too, has exposure to non-performing mortgage assets in their investment portfolios. However, with more than 3,000 institutions insuring property-casualty risk in the United States, the industry has a lower concentration of risk as compared with commercial and investment banks. Let’s hope that Congress proceeds more carefully with the legislation proposed by Treasury.