A lot was written in 2008 about the moral hazard of the federal bailout of the banks and financial institutions during the great recession. Then Treasury Secretary Henry Paulson was quoted as saying
the Fed made “the right decision” and expressed “great confidence” in its chairman, Ben Bernanke. Paulson said that in the case of Bear Stearns, the risk to financial stability outweighed his concern about so-called moral hazard, in which investors come to expect government rescues.
I was reminded of this when I read this interview with hedge fund manager Hugh Hendry. A self confessed bear who capitulated in the wake of central bank intervention. The full interview can be read here, but this was what I thought was his most important point:
I have concluded that my risk tolerances were too taut and it was creating too much of my own intervention, in the portfolio, and it was damaging to the client’s performance. So I’ve pulled back or I’ve widened the tolerance of the portfolio.
Merryn (Interviewer): So your basic point here is that if the central banks have your back, there’s no need to have the same kind of risk controls that you used to have.
Hugh: There is less need. Less need. I tell you, I was at a conference with some of the great and the good global macro managers in September in New York and I asked them all the question, “If the S&P is down 12% what do you do? Are you selling more or are you buying?” Guess what? They’re all buying. So the central banks have created a behavioral tic which is becoming self-reinforcing and I believe we saw another manifestation of that behavior in October.
We have seen government/central bank intervention in the US, we are seeing government intervention in Japan, and we are about to see it in Europe. Yet nobody is talking about the moral hazard this presents and, according to Hugh Hendry, is leading to a widespread increase in risk taking in the financial community.