The Policy Making Moral Hazard: The Bailout Mentality

To give you an example how the ‘Bernanke Put’ or the ‘Bernanke doctrine’ has worked to ingrain the psychology of moral hazard to the Financial industry, here is an example where Panic is seen as a buy, principally because of the political ‘need to do something’.

In short, the bailout mentality.

From analyst Martin Spring (bold emphasis mine)

If there is another major crisis – perhaps deadlock in Europe as voters in the North torpedo plans to implement a fiscal union and prevent issuance of bonds for the Eurozone as a whole, underpinned by the power of the German economy – or even just a general worsening in the global economy, with employment and/or property crisis in the US, then it’s very likely that that will panic policymakers.

-Central banks will go crazy with “printing” and otherwise unorthodox money-pumping policies;

-Despite growing public resistance to rising federal debt in America, and to “rescue” packages in Europe, governments will find ways to spend more to stimulate demand;

-In Asia, where sounder fundamentals allow policymakers more freedom of action, there could be a switch from fighting inflation to promoting domestic demand.

Of course, such changes could build up even greater problems for the future, such as the eventual threat of serious inflation facilitated by the money bubble. But the political imperative will be to do something… anything… immediately, to ward off disaster.

The equity markets will love such a panicky turnaround. The next couple of months at least … maybe longer… will be the time to use most of the cash that you should have realized and parked awaiting such an opportunity, to invest in shares.

Mr. Spring is right, a realization of this short term political patchwork would essentially translate to crisis begetting more crisis.

Nevertheless, political actions are almost always focused on short term (palliative) effects and directed at attempts to resolve problems of politically 'favored' sectors.