Tuesday, December 16, 2003

The Dukes of Moral Hazard 
I’m (ahem) borrowing this term from the financial world. Essentially, the doctrine of moral hazard means that the lender must accept responsibility for the credit risk of the borrower. If the lender feels that he can rely on government or the courts, or any other third party to bail him out of a loan gone bad, then he will have no incentive to perform normal due diligence on the credit-worthiness of the borrower. Rather, when you remove risk from the lender’s equation, he has a perverse incentive to lend his capital to the riskiest debtors he can find, since those loans pay the highest yields.

(We’ve seen this logic play out before, domestically, in the central American debt crisis of 1981-82, when Citibank and Bank of America both found themselves overexposed to central American debt in the middle of an economic collapse there—so severe that it threatened the financial structure of the entire U.S. banking system--and the S&L Bailouts of the late 80’s and early 90’s.)

If France, Germany, Russia, and others lent more money to Saddam’s regime than they can afford to simply write off in a spirit of largesse, then doesn’t that raise serious questions about the financial and moral judgement of their own bankers?

If we hold ordinary Iraqis’ feet to the fire and force them to repay these loans, we risk compromising the principle of moral hazard. French, German, and Russian capitalists will continue to lend their money to profligate and irresponsible regimes, confident that the debts will be made good—at UN and U.S. taxpayer expense, if necessary—even if their scumbag creditors collapse in a hail of bullets.

Now, I don’t think the United States is going to declare Iraq’s debts “odious” and unilaterally erase the debts. It is simply not necessary for us to do that ourselves. To do so would needlessly roil U.S. relations with France and—more importantly—Russia, all over again.

European bankers should begin to accustom themselves with the taste of a mouthful of sand. By next summer, Iraq’s new government becomes fully sovereign.

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