Bailout out of Ethics

More and more governments decide to bailout banks that got into trouble due to recent price changes in American real estate market (the so called “housing bubble burst”). Contrary to most commentators who write about economics I do not want to get into details of the situation. Lots of articles has already been written, more are surely to come and I do not feel like contributing anything really new or valuable to what is already present in the media. I just want to mention briefly the question of business ethics.

What we are facing is the never disappearing problem of moral hazard, which in this situation means that the management of the institution that has been given financial support out of public pocket is going to behave without proper caution that would allow it to avoid similar problems in the future. It will feel encouraged to take even riskier actions, expecting to be rescued again in case something goes wrong.

Then we have another question, touching on the distribution of responsibility that such institution shows towards its market and political environment (or stakeholders). It can be safely assumed that organizations feel responsible mostly to entities that provide them with monetary and non-monetary transfers. They just want to get along with their clients, in a very broad meaning of this word. What bailouts do is that they shift this responsibility from market stakeholders to political ones. This is caused by different potential behavior of both groups in case of crisis. The first one will try to abandon the sinking ship of its bank (or mutual fund or whatever institution you want to name), making its problems even more severe. At the same time, the second group seems to be eager to provide a rescue plan financed out of somebody’s else pocket. After all, if they did it once then it is likely that they will repeat the same maneuver next time.

What we can expect to follow from the above is further widening of the gap between market expectations and actual actions of financial institutions that has been (or are going to be) bailed out. It will just make less sense to behave in a way that pleases customers. Instead, doing what politicians want will become more rational. This will show not only in a way clients are treated but also in how the institution as a whole acts.

These consequences have been already reported in the media. Just one week after their company has received another emergency loan extension from the government, AIG executives spent $440 000 on making themselves comfortable. Maybe it has been planned for over a year, at least this is what AIG claims. But what really matters is why the conference was not called off. This is exactly what a company feeling responsible for its mistakes would do. It would want to show its customers that it respects them and their money.

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