terça-feira, fevereiro 21, 2012

It takes three to generate moral hazard

In economic theory, moral hazard is a tendency to take undue risks because the costs are not borne by the party taking the risk, so says wikipedia succintly.
We can find moral hazard both on the borrower and on the creditor side, as long as the taxpayers bail  out the borrower or the creditor, or both.

Let us take:
1. a weak borrower (ex.  REFER),
2. a foolish creditor  taking undue credit risks with more money than credit analysis skills (a Schuldschein bond investor), and
3. a hapless taxpayer (o contribuinte coitado) on the side of the borrower or of the creditor having to bear the cost of the doubtful loans

When a borrower cannot afford to repay its excessive debt, the loss may be shared more or less equitably between borrower and creditor, or taken by the borrower's or the creditor's Government .  REFER borrowed money it could not afford to repay, the Schuldschein investor did not even bother to demand the Guarantee of the Portugusese Republic.   Now the bonds are trading at deep discounts, but when they come due, the Portuguese Goverment pays them off at par, and inevitably assumes the debt of the State owned companies, keeping the full loss for the account of the Portuguese taxpayers.

See SOE debt coming home to roost 
Estado assume dívida do SEE de transportes