Re-Examining U.S. Bailouts In The Digital Era: Moral Hazard and Adverse Consequences

Financial institutional bailouts have become the new normal in recent decades. From the savings and loan crisis, to the sub-prime, to SVB and Signature, the U.S. government and regulators have decided that the failure to protect depositors and investors could lead to bank runs, a destabilized banking sector, and ultimately economic turmoil inflicting tremendous monetary and social costs on citizens. However, the mainstreaming of bailouts has led to moral hazard, i.e., the expectation among all stakeholders including financial institutions, investors, creditors, and regulators, that a government rescue is inevitable. The problem of moral hazard is the creation of incentives to engage in riskier business decisions, such as lending to more speculative borrowers, offering above-market rates to creditors, or engaging in criminal conduct.

Indeed, despite bailouts—or perhaps because of them— irresponsible speculation, excessive risk-taking, and misconduct continues unabated. Thus, because losses arising from bad behavior are in essence “insured” recidivism is encouraged thereby raising the question of whether bailouts themselves constitute a proximate cause of financial crises. As U.S. financial institutions are allowed to interact with digital assets such as Bitcoin, and new financial intermediaries are integrated into the financial eco-system, the question of whether moral hazard proximately causes crises is of significant importance.