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Henry Paulson's Moral Hazard In The Banking Industry

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Moral Hazard by definition is when a person or company takes on a risky venture knowing that they are protected against the risk and another party will incur the cost. Henry Paulson former head of Goldman Sachs and at the time of the Wall Street meltdown served as the Secretary of the Treasury used the term moral hazard when dealing with investment banking houses. Moral hazard to Paulson meant that bailing everyone out ensured that they had no incentive to succeed and would not avoid the dangers next time. To Paulson someone had to fail as an example and they would be Lehman Brothers Holdings. Wall Street banks were intertwined and the systemic risk of allowing a major bank to fail would have repercussions throughout the banking industry. How…show more content…
But this time would be different. Henry Paulson stepped in to let Lehman Brothers know there would be no bailout for them. Someone had to fail to set an example for the rest of the banking industry and Lehman Brothers would be that someone. In Paulson’s view Lehman Brothers was guilty of moral hazardous decisions and would not be paid for mistakes made. I find it interesting that Richard Fuld the CEO at Lehman Brothers at this time was Paulson’s chief competitor before becoming Treasury Secretary. Why was Lehman Brothers by the way of Paulson’s moral hazard decision making? They were a large bank and posed greater systemic risk to the overall industry than Bear Stearns. Paulson told Fold to make a deal with another bank or risk bankruptcy. When no deal could be made Paulson told the Wall Street banks to solve the problem collectively since they created the problems collectively. With no end in sight Paulson eventually shelved his moral hazard standing and was forced to make loans to the largest banks in America. Two of the largest companies in the world were United States banks and had lost almost 60 percent of their value. United States banks held nearly 5 trillion in mortgages. AIG alone held billions in credit default swaps and would eventually need nearly 185 billion in government loans to remain in business. AIG famously was deemed too big to fail. The government now controlled the largest insurance company along with Fannie Mae and Freddie Mac the largest mortgage banks on
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