8 September 2017

Moral hazard, QE and the crisis of popular capitalism

By George Maggs

While most people recognise the need for some form of social safety net, they are also acutely aware that with that net comes the danger of  “moral hazard”, with people incentivised to “free ride” by relying on state handouts and subsisting on benefits funded by the rest of us.

This moral hazard can make people angry, and so they are generally sympathetic when governments take measures to ensure only the most vulnerable are supported by the state. Yet people feel equally aggrieved when moral hazard is created in other areas too, such as business or finance.

Here however, Conservatives are perceived (not without justification) as maintaining a double standard: happy to introduce a benefits cap and work capability assessments, but wary when it comes to condemning the eye watering sums doled out to wealthy bankers and financiers in the wake of the financial crash.

Although it was Labour under Gordon Brown that oversaw the deregulation of the City and the bailout of the banks, Jeremy Corbyn is sufficiently distant from that wing of the Party to be associated with these actions.

It is instead the Conservatives who have become associated with post-crisis policies in the eyes of the public. And it is these policies which have contributed to moral hazard in a number of ways.

Most obviously, the banks were bailed out by taxpayers to the tune of hundreds of billions of pounds. Bankers’ free-riding behaviour was left unpunished, while ordinary citizens carried the can.

Secondly, the ultra-low interest rates imposed from Threadneedle Street not only acted as a subsidy to the banks by reducing their borrowing costs at the expense of depositors, it also caused an unprecedented shift in income away from savers (the majority of UK savers having less than £50,000) and towards borrowers. This effectively transferred revenue from predominantly middle earners saving for retirement or for their first home, to buy-to-let landlords and those with enough collateral to borrow to invest.

Thirdly, Quantitative Easing – the purchasing of financial assets by the Bank of England – allowed banks to dispose of unwanted assets generated during the boom without making losses, enabling them to free ride by transferring risk to the Bank of England. But more than that, it also created a huge boost to asset prices and lowered the cost of borrowing. This exacerbated wealth inequality by increasing the “unearned” wealth of investors and home owners, pricing everyone else out of the market.

These interventions therefore didn’t just reward the risk-taking behaviour of bankers, they also oversaw a huge transfer of wealth from the less well-off, to the already wealthy. Hardly surprising then that socialism is back in vogue.

So what should be done?

The 1980s were such a success in large part because the Conservatives facilitated the affordability of capital. The “right-to-buy” for council tenants was critical, encouraging aspiration and enabling council tenants to attain the security of home ownership. The privatisation of state monopolies with discounted share prices for small investors likewise enhanced people’s faith in capitalism.

Under the present government however, aspiring capitalists are being hit from both ends; through insurmountable property prices and virtually zero return on their savings. People are unlikely to believe in capitalism, or in a party which proclaims the virtues of free markets, if they have virtually no prospect of owning capital themselves.

To re-claim the initiative and restore faith in the system, the Conservatives must regain the courage of their convictions by tackling moral hazard wherever it is to be found – not just in welfare. They could start by increasing the power of shareholders to force CEO pay to become more closely aligned with performance; or by legislating to prevent the merry-go-round of public sector executives who seem increasingly able to profit from failure at the taxpayer’s expense.

They must also attempt to undo some of the damage inflicted by “Osbrown” post-crisis policies by adopting a more radical policy platform. One way this may be achieved could be to begin to replace income with wealth taxes. As I argue here, this could go some way to making the dream of property ownership more achievable for those without recourse to the bank of mum and dad. It would also encourage aspiration by allowing people to retain more of their own income and restore (or perhaps establish) many young people’s faith in enterprise and free markets.

Conservatives are right to draw attention to the dangers of moral hazard, but measures to prevent it must be taken across the piste, especially and without exception at the top. The preservation of freedom may depend on it.

George Maggs is a political economy researcher at the University of the West of England.