When Congress was constructing its economic stimulus bill in February, Democrats attempted to insert a provision that would have extended unemployment benefits by 13 weeks. Republicans would have none of it: Doing so would create an "incentive for people who could otherwise be employed not to be employed," sniffed South Dakota Senator John Thune. That's the way moral hazard works: If government helps those in need, it just creates an incentive to act irresponsibly.
If Republicans had followed this line of logic when investment bank Bear Stearns threatened to collapse last week, they should have quickly rejected the idea of a federal bailout. After all, Bear had acted irresponsibly, aggressively embracing the preposterous notion underlying the current financial crisis: that real estate prices would keep going up, making otherwise indefensible subprime mortgages a good investment. Surely it would be a mistake for the feds to sweep to the rescue and thereby encourage such recklessness.
Well, maybe not. The Bush administration agreed to step in, and Treasury Secretary Henry Paulson brushed off the moral-hazard argument; the firm had already suffered enough. "If you would ask Bear Stearns shareholders in terms of what had happened to their value, I don't think any of them would think this was good for them."
He has a point. But the episode serves to illustrate the fallacy of Thune's argument. No one who loses his or her job is very happy about it, either, even if unemployment benefits are available--so, during a recession, such benefits have a minimal adverse impact on employment levels. It's more than a little troubling that the Bush administration finds it so much easier to sympathize with the plight of Wall Street titans than with that of ordinary Americans.