Useful Anger: AIG Illustrates the Importance of Pitchforks

A lot has been argued against the public's anger over AIG. But intuitively, I've been feeling that the over-the-top anger, the extreme Congressional reactions, the actual public intimidation of bankers, while vague, undirected, and perhaps counterproductive to immediate goals, has actually been important. I might not go as far as Bill Mahr and suggest that a banker or two be strung up from a tree. But I've been feeling that the kind of public intimidation and scapegoating has had a valuable aspect, and today, it occurs to me why.

But first, let's examine the reasons the anger has been counter productive. All are good arguments, and here they are:

1. From the left: That the anger makes it tougher for Geithner and company to get banks to go along with governmental plans to fix the economy.

2. From the right: That vilifying bankers makes it more difficult for capitalism to do its job in turning around the economy.

3. From the middle: That now that AIG is run by the government, hurting AIG only hurts the taxpayers.

4. From bank employees: That most of the people receiving bonuses from AIG aren't responsible for the bad bets that caused this mess, and are essential to helping successfully unwind AIG responsibly.

5. From government watchdogs: That it's a bad idea for Congress to create laws that overreact and attempt to hammer a nail with a bulldozer.

6. From debt watchdogs: That it's short-sighted to focus on 1/500th of the money involved in AIG at the risk of putting much more of that money at risk in a failed recovery.

All perfectly good arguments. But as I watch busloads of angry protesters touring rich towns in Connecticut, as I read AIG executives talk with pique in NYTimes editorials about donating some of their bonuses to charity, and I watch Congress pontificate and the mobs roil on late-night TV, I think that there is one very GOOD thing that this anger is doing. The one good thing: It helps to return the idea of moral hazard to its proper place.

What is moral hazard? As this crisis has evolved, we've seemed to have forgotten this essential concept. But moral hazard is essentially why the Fed let Lehman Brothers fail (and precipitate this mess) in the first place. Moral hazard is the idea that if there is no downside to making bad bets, because the government will step in and help you, then this only encourages even more risky behavior in the future. It seems that in order to save the economy, the government has decided it has to ignore moral hazard.

What's heartening about the AIG anger is that it seems that moral hazard can't simply be wished away. Like the concept of "momentum" in physics, perhaps moral hazard can't be destroyed but has to simply show up someplace else: like anger at AIG. If AIG employees find themselves intimidated, targets of vilification, then moral hazard has done its job: it's shown that there WILL be a price to pay, in some way, for making extremely risky bets.

My feeling is that letting this moral hazard play out is more important, in the long run, than the damage caused by points 1 - 5. And so I cheer on the AIG anger...and hope that the government sees how it can use the anger to maintain a sense of moral hazard, while also taking the short-term business-friendly steps to get our economy going again.