The term “moral hazard” is used often in economics, resurfacing every time America faces a calamity. During each of these “once in a lifetime” moments, which seem to happen once a decade, the private sector craves that which makes all enterprise tick. In these crises, business yearns for predictability, certainty and transparency.
It also yearns for protection — and the coronavirus crisis is no different, with the private sector looking to the U.S. government to provide it with a safety net during these uncertain times.
Yet it is apparent that no part of life in these times is certain, and government support can be a double-edged sword, offering an immediate salve to stabilize the economy but at the potential cost of handicapping it in the future if it buckles under the weight of excess debt.
This financial risk, however, is the price we must pay to prevent a total collapse of the economy right now. Likewise, we face the moral dilemma of rescuing the economy at the risk of human lives if coronavirus cases surge and spread. But this is a false dichotomy because with the right long-term strategy and strong global cooperation, the United States is capable of tackling this twofold challenge.
That’s why what we do in the coming weeks is so important, because it will affect the following months, and those months will inform the medium- to long-term trajectory of the U.S. economy for years to come.
In economics and finance, moral hazard exists when a protected business will engage in riskier-than-average behavior by virtue of the fact that it is protected (such as when it is covered by insurance). Thus, an entity increases its exposure to risk because it does not have to bear the full costs of that risk.
In line with our current reality, the Federal Reserve has done its duty by making the cost of borrowing cheaper than ever before. This move, in theory, encourages businesses and individuals to borrow, which in turn should encourage spending and investment. Warren Buffett, in his latest Berkshire Hathaway shareholders meeting in May 2020, said that the recent actions of the Fed should be lauded, but not without recognizing the potentially extreme consequences for the U.S. economy down the road.
Buffett, along with another legendary investor, Jim Rogers, have sounded the alarm on rising debt levels for years, emphasizing corporate debt. As of April 2020, U.S. consumer debt was at a historic eye-popping figure of $14.3 trillion (yes, with a “t”) — a number roughly $1.6 trillion more than the worst levels during the 2008 financial crisis. The corporate debt bubble should raise even more concern than the consumer bubble, and the Fed’s announcement that it will begin to purchase corporate high-yield — referred to as “junk” — bonds has emboldened many participants of capital markets to take on more risk.
The Fed has signaled it will buy the corporate debt/bonds of “fallen angel” companies that have been downgraded due to Covid-19 concerns; that includes household-name companies such as Heinz and General Motors, and companies with specific strategic national importance such as Boeing and Delta.
Does the Fed backstop make our private sector grow back faster, or encourage risk-taking with the knowledge that the government will be there to prop them up if they fail? These notions give rise to moral hazard in the traditional economic sense, but in the context of a pandemic, the necessity for action trumps the debate over long-term consequences.
It is critical for all governments to step in and perform the difficult, yet critical, measures needed for the economy during its darkest hours, even if they might have long-term consequences. The U.S. is also not alone in these measures; the actions of the Federal Reserve are being mirrored by the European Central Bank, the Bank of Japan and other leading financial regulators — and rightfully so in a crisis of such global nature.
At the same time, it is important to highlight the emergent moral hazard in our country — the false choice between saving life and saving the economy. As many other developed countries will attest, this situation should not be an either-or choice. With the right strategy, the U.S. can both save lives and its economy. The key is a strategy that is well-defined, has buy-in and is broad in scope.
Nobody professes to have all the solutions to this crisis, yet it is important to ask questions, seek answers and accept the realities of what we as a country, and as a human race, will be forced to endure. In doing so, it is also important to consider what will define the overarching strategy in the months ahead, and how that strategy varies from tactics. Tactics refer to the skill of handling difficult situations to achieve a specific goal. Strategy is defined as a comprehensive, high-level, long-term plan.
The question, then, is what is the U.S. overall strategy for the coming months? Testing and tracing are tactics, but not strategy. By all accounts, the U.S. has done more testing than many other developed nations, and knowing the prevalence of the virus in the population can offer precious data to feed into broader strategy. But if that data does not inform a strategy, what good is it?
Moreover, testing is not the cure-all that many tout it to be, according to Laurie Garrett, a Pulitzer Prize-winning author and one of the first to sound the alarm on Covid-19.
Garrett spoke to Frank Bruni of The New York Times for a recent article in which she said that what America needs right now “isn’t this drumbeat of testing, testing, testing, because there will never be enough superfast, super-reliable tests to determine on the spot who can safely enter a crowded workplace or venue, which is the scenario that some people seem to have in mind,” Bruni wrote.
“America needs good information, from many rigorously designed studies, about the prevalence and deadliness of coronavirus infections in given subsets of people, so that governors and mayors can develop rules for social distancing and reopening that are sensible, sustainable and tailored to the situation at hand.”
It is a false assumption that people who want to save lives want to ruin the economy, and it’s unfair to label those who want to see their businesses reopen as callous toward the sad, but inevitable death that will occur as a result. While the goals of Wall Street, the U.S. government and the public may seem vast and contradicting, we must realize that there is only one goal: controlling and eliminating the virus.
Our strategy needs to be grand and bold, in the spirit of the virtues that made our country great to begin with. It must be global in scope while local in practice, and we must realize that tackling this crisis needs to be done together, even while staying apart.
An all-out political, social, economic and trade policy response is needed, and this will require international buy-in and support. Our international institutions will be tested in a way like never before, and this will inform the future of the post-World War II era that America helped shape and define. We must come together to collectively envision a future in which the virus is gone because of the actions we took now. America needs to lead this effort globally, but this path cannot be taken alone and will require joint commitment by the entire world. American leadership is needed now more than ever, and while leadership is hard to define, it is easy to identify.
The moral hazard we face today is not whether companies will misuse their stimulus relief or start buying back their stock to deliver greater shareholder returns. America’s private sector contains some of the finest corporate citizens in the world, and nearly all companies want to do right by all their stakeholders — and not direct shareholders exclusively.
The real moral hazard we face is the false choice between saving lives and saving our economy. America, along with its allies and other major nations, must face this challenge head on, and international cooperation, coupled with an overarching strategy, intense knowledge sharing and other major nations, must face this challenge head on, and international cooperation, coupled with an overarching strategy, intense knowledge sharing and truth telling, will be the key to our recovery and eventual return to normal.