To induce a bank to choose to make prudent investments, the
bank must have sufficient franchise value at risk ... Capital
requirements also have a perverse effect of increasing the bank's cost
structure, harming the franchise value of the bank ... Even in an
economy where the government can credibly commit not to offer deposit
insurance, the moral hazard problem still may not disappear."
Moral hazard must be balanced, in the real world, against more ominous
and present threats, such as contagion and systemic collapse. Clearly,
some moral hazard is inevitable if the alternative is another Great
Depression. Moreover, most people prefer to incur the cost of moral
hazard. They regard it as an insurance premium.
Depositors would like to know that their deposits are safe or
reimbursable. Investors would like to mitigate some of the risk by
shifting it to the state. The unemployed would like to get their
benefits regularly. Bankers would like to lend more daringly.
Governments would like to maintain the stability of their financial
systems.
The common interest is overwhelming - and moral hazard seems to be a
small price to pay. It is surprising how little abused these safety
nets are - as Stephane Pallage and Christian Zimmerman of the Center
for Research on Economic Fluctuations and Employment in the University
of Quebec note in their paper "Moral Hazard and Optimal Unemployment
Insurance".
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