Do moral hazards matter?

I recently had a lengthy conversation with a friend about healthcare and the housing market collapse. In the conversation, I attempted to illustrate my perspective based on my friend's personal investing practices.

So a little background on options and puts before I go on. In derivatives, "puts" can be purchased to protect yourself against declines in stock prices. Say I buy Microsoft stock for $25 a share. At the same time, I could buy a put that enables me to sell the stock to someone else at some point in the future for $25. So if the stock goes down to $20, I can "put" my shares to someone else for the pre agreed price of $25, and save myself from losses.

But the put costs me money, so I balance the risk of losing on my investment against the cost of the put.

Back to my friend. I asked my friend how my friend's investing would change if every stock purchase came with a free put. Meaning my friend could never loose money, only got the upside, and all of the declines in value would be covered by the free put. My friend acknowledged the new strategy would be to leverage everything to buy as much as possible to take advantage of the risk free profits. This is called a moral hazard.

I pointed out that the housing/mortgage market had been covered by several of these free or undervalued puts in the form of implicit and explicit "too big to fail" thinking.

My friend responded, "Moral hazard had nothing to do with it!"

So I ask, does moral hazard apply? If moral hazard applies to the individual, why would it not apply to the whole market? Does moral hazard have anything to do with it?

Me for President!

A Prediction

Corrupt, Incompetent, Hope: The order of succession.

It seems to me that after a particularly corrupt administration, the American electorate's next selection is typically someone who is perceived as moral or ethical, but turns out to be ineffective, or even incompetent. The one-two punch of corruption and incompetence leaves us demoralized; the next guy to come along offering hope is elected.

Consider the Nixon administration as corrupt (Ford was care-taker), we then elected Carter hoping for moral or ethical, and we got incompetence. Demoralized and humiliated, we turned to an orator who offered us hope, and we elected Reagan.

The cycle restarted with the Clinton’s "scandal-a-day" corrupt administration, followed by Bush, the ineffective communicator and leader. Next we will turn to an orator offering hope -- Obama.

Lead the Way, Al

Data from the Tennesse Center for Policy Research, if accurate, reveals Al Gore's hypocrisy.

The Survey Says...

I'm trying something new here. I'd like folks to vote by leaving comments below.

The government has regulated and mandated minimum wage for a long time. Many see this a necessary to sustain a living wage. Others see it as a form taxation or taking from the rich to give to the poor.

But now there is a new outcry about the other end. The CEO of Morgan Stanley was paid 40 million for a year of work. The CEO of Home Depot was paid 210 million to leave. A-Rod gets 29 million to play a game. Oprah brings in 225 million and Rush Limbaugh is rumored to make about 25 million a year. See the list of the top paid celebs.

My question is this: Should the government regulate how much money you are compensated, both minimum and maximum?