Moral Hazard

Moral hazard is the tendency of people and institutions to take greater risks when they expect someone else to bear the cost of failure. The term became a fixture of monetary debate after 2008, when the US authorized $700 billion under the Troubled Asset Relief Program to rescue institutions whose own bets had failed.

Why it matters

When large financial firms learn that losses will be socialized, prudence becomes a competitive disadvantage: the firm that levers up earns more in good times and is rescued in bad ones. Each rescue ratifies the expectation, encouraging the next round of risk-taking. Critics trace a chain from the 1998 LTCM intervention through 2008 to the 2023 regional bank failures, where uninsured depositors at Silicon Valley Bank were made whole. Deposit insurance, too-big-to-fail status and central bank backstops all carry this trade-off between stability today and fragility tomorrow.

In the gold vs bitcoin debate

Hard money advocates argue moral hazard is a symptom of elastic money: bailouts are possible only because new money can be created to fund them. Under a strict gold standard, rescues were constrained by reserves. Bitcoin extends the logic further, since no authority can issue coins to backstop anyone, and failures such as FTX in 2022 were absorbed by their creditors rather than by dilution of every holder. Critics respond that letting institutions fail without backstops has historically produced deeper panics, which is exactly why lenders of last resort emerged.