What are the Ethics of Interest Rates?

New York Times columnist Joe Nocera discusses the economic definition of "moral hazard" and what it has to do with the Federal Reserve's decision to lower the interest rate.

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SCOTT SIMON, host:

Listen to some market analysts and they'll tell you that the credit crisis is all the fault of the Federal Reserve. They say investors took bad risks and prospective homebuyers took on mortgages beyond their means, securing the knowledge that the government would make them whole if their investments failed.

And that debate has brought attention to a phrase that's long been common in economic circles but not often heard by the public until maybe this week - moral hazard.

Essentially the concept is that people will take greater risks if they feel there'll be little or no consequence. So after the Fed cut interest rates by half-a-point, Wall Street buzzed with talk that the Central Bank created moral hazard by letting investors off the hook.

We're joined now by Joe Nocera from our studios in New York, our New York Times columnist friend from the world of business.

Joe, thanks very much for being with us.

Mr. JOE NOCERA (Business Columnist, New York Times): Thanks for having me, Scott.

SIMON: Now, in the eyes of critics, how has the Fed encouraged moral hazard?

Mr. NOCERA: This is really an issue that has come up most dramatically in the last week after they did that half-point rate cut, which was larger than anybody thought. And they did it, in part, because they say they were worried about the economy. But the critics are basically saying, look, investors did dumb things. People who bought homes they couldn't afford did dumb things. People who were making subprime loans did dumb things. They all took risks they shouldn't have taken in this old-heated bubble.

And now, the Fed is saying instead of take your medicine and don't do it again, they're basically saying we're going to lower interest rates, make the economy better, try to keep assets of the housing prices high, in effect take everybody off the hook. That's what the argument in this particular case is about. It's not an insignificant argument, and it's one that sort of rippled through the currents of modern American economic history, practically since the new deal.

FDR was trying to revive the economy. And by putting all sorts of - sort of safety stops and guarantees and things that gave people confidence in economic life, many, many, many economic conservatives said this is terrible because it takes the risk out and allows people to do things they wouldn't otherwise do.

SIMON: How does the Fed balance these strings of responsibilities? On the one hand, they're supposed to, you know, essentially stand back and let the economy, on its own, establish a normal functioning, safe and secure bases. Yet on the other hand, they are there to protect the economy.

Mr. NOCERA: It's very unusual to see the Fed kind of on the defensive for having made a move that will stimulate the economy. But they are very much on their heels in the wake of this because they're out there saying, look, we're not trying to protect investors and we're not trying to protect even homebuyers, but we are trying to protect the economy because we're worried that if our housing prices dropped too low or, you know, credit dries up too much that the economy will grind to a halt so we have to grease the wheels.

The critics basically say the economy wasn't that bad. You're overreacting. And, you know, you basically should allow a little pain because that will help remind people, the next time around, that this is what happens if you take too much risk and get too giddy in a bubble.

SIMON: The last time I think I heard the term moral hazard applied so dramatically was, of course, following the terrible losses in Louisiana and Mississippi after Hurricane Katrina. When the issue was raised, it was moral hazard at work when all kinds of different agencies enabled the development of coastlines that people knew at one point or another would be vulnerable to hurricanes.

Mr. NOCERA: Well, I would argue that moral hazard is at work in those instances. You know, there's a reason insurers don't insure for floods because they know that the consequences of a coastal hurricane can wipe them out. So they opt out. And so the federal government has basically come in and said, okay, we will offer federal fund insurance, which has given people the confidence to build homes all up and down the coasts. And people love living on the coast. It's a wonderful thing. But it comes with enormous risks.

And put New Orleans aside and just talk about the coastlines, and you can make a pretty strong argument that that government program has given people the feeling that they can live on the coast, their house can be wiped out, and they will be, in some way, made whole. Is it better to have people get federal flood insurance and live on the coast, or would we, as a society, be better served if the federal government says we're not going to do that, you're on your own if you live on the coast. That's what makes it such a tricky and interesting and difficult question.

SIMON: Joe, thank you so much.

Mr. NOCERA: Thanks a lot, Scott.

SIMON: Joe Nocera who has a column in Saturday's New York Times.

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