Andrew Willis: The credit crunch and moral hazard

Money Talks is a collection of daily columns from The Business Network, which airs weekday mornings on CBC Radio One at 5:45 a.m. ET (6:15 a.m. ET in N.L.).

By Andrew Willis, a columnist with the Globe and Mail
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Ever heard of a concept called moral hazard?

It's the idea that people who are insulated from risks behave very differently from those who bear the full responsiblity for their actions.

In other worlds, I'll drive my car like an idiot if I'm insured against all accidents, while I'm far more careful if I have to pay a $2000 deductible on any fender bender.

The Canadian bank CEOs are fretting about moral hazard right now. The banks are on the verge of being forced to do something that will encourage reckless behaviour in financial services.

Here's the background.

As you likely know, there's this massive freeze in what's known as the commercial paper market, based mostly on derivatives. $35 billion of this debt isn't trading. All of that paper was created by companies that compete with the Canadian banks. The banks have their own commercial paper, and it's doing fine.

Lots of smart people are trying to thaw this frozen commercial paper market. To help the process along, the Bank of Canada and other interested parties are asking the five big banks lend a hand, by lending about $500 million each as part of the rescue package.

The bank CEOs, including TD boss Ed Clark, are quite rightly worried about shouldering this risk.

Competitors to the Canadian banks created a mess. The banks steered clear of this disaster, yet now they are being asked to help clean it up, for the good of the whole market.

I suspect that in the end, the banks will help out. But the precedent is ugly.

Upstart financial firms created products that crashed. When the accident happened, folks who were far more prudent with their money are paying the bills. There's now a moral hazard in the Canadian market.

-- Andrew Willis

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