A Riskless Society Is Unattainable and Infinitely Expensive

Favorite Excerpts (Via CFA Institute)

A democracy can only exist until the voters discover that they can vote themselves money. —Popular saying, origin unknown
Private vices will always thrive. Greed, envy, lust, pride, and my favorite, sloth (I can’t help thinking of the two-toed, upside-down mammal) will continue to drive human action as they always have. Some argue that greed is good. They have a point. Greed certainly makes the engine of the economy hum. Like Adam Smith, I would rather get my dinner from a merchant acting in his own interest than from one pretending to act in mine. Through the processes described by Smith, private vices are channeled in such a way as to produce public benefits.2 This transformation is well known to studentsof economics and is seeping through to the general public.3 But it does not work perfectly all the time. Private vices are restrained by what Smith called “enlightened self-interest.” If you are too greedy, you stand a chance of losing money. Regarding lust, as Danny O’Keefe sang in “Goodtime Charlie’s Got the Blues”: “you play around, you lose your wife; you play too long, you lose your life.”But private vices with no corresponding public benefits are encouraged when

individuals are protected—or think they are protected—from any negative consequences that might arise while getting to keep the rewards. This chain of cause andeffect is what economists call “moral hazard,” a phrase that has been growing in familiarity since global capital markets began to collapse in 2007 and as the collapse intensified in 2008 and the early part of 2009. The decline in market values, amounting to 57 percent from peak to trough as measured by the daily closing value of the S&P 500 Index of U.S. equity prices, revealed that once-proud financial institutions and other corporations had experienced losses on a mammoth scale.4 These losses were so large, and the institutions so interconnected through complex contracts and financial instruments, that the whole global financial system was at the point of collapse. Parts of the system actually stopped functioning: For a few weeks in September and October 2008, many healthy businesses could not obtain short-term credit at any price. Although financial conditions have improved dramatically since then, substantial long-term economic challenges remain.

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About Miguel Barbosa

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05. February 2010 by Miguel Barbosa
Categories: Curated Readings, Risk & Uncertainty | Leave a comment

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