Wednesday, September 19, 2007

Moral Hazard Insurance


Moral Hazard: The risk that a party to a transaction. . .has an incentive to take unusual risks in a desperate attempt to earn a profit before the contract settles.

I think that is very risk that the Federal Reserve took yesterday when it decided to lower its rate on a key short-term interest rate by half of a percentage point Tuesday to 4.75%. A bubble was created in the credit market which contributed to asset inflation in the housing sector. Obviously (to me, anyway), the fact that the markets immediately saw an increase in the price of gold, oil, metals and other commodities indicates that traders expect the Fed's action to lead to inflation in commodity prices -- particularly gold and oil. Oil is currently priced in dollars and gold is often bought as a hedge against inflation.

So where does one go to buy insurance against the moral hazard of bailing out speculative investors and financial institutions that made what they knew were bad loans?

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