Friday, December 8, 2017

Reinforcing Moral Hazard

Jacob Moore: You know what moral hazard is, Ma? You know what that means?
Sylvia Moore: No.
Jacob Moore: It means that once you get bailed out, what's to stop you from taking another shot?
--Wall Street: Money Never Sleeps

The gist of this article, including the accompanying graph below, is that central banks no longer have to intervene in markets because investors have 'learned' from previous interventions that they will be bailed out by CBs should market actually decline.

Thus, we have investors buying all dips in competition to be early entrants into subsequent rises that would have been backstopped by the Fed et al. had those dips been deep enough. Follow that?

Due to CB-facilitated moral hazard, the reinforcing loop creates what appears to be a self-fulfilling prophecy of higher markets.

If one buys into this thesis, then the question becomes: what breaks this reinforcing cycle?

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