NEW YORK (

TheStreet

) -- "Moral hazard" is a term frequently thrown around as a reason to break up financial institutions considered "too big to fail," but the academics and policymakers making that argument may be oversimplifying the problem.

Moral hazard occurs when a person or company is incentivized -- for instance, by having access to inexpensive insurance against losses, or having confidence in being bailed out if they are subsumed by losses -- to take excessive risks. In testimony before a House committee examining his proposal to address the too-big-to-fail issue on Thursday, Treasury Secretary Timothy Geithner went beyond previous statements to say that big banks may be forced to shrink, because the bailout actions of the past year had created moral hazard. But the moral hazard issues in the banking industry aren't quite so cut and dried.

Few banks are eager to take federal money to shore up their balance sheets. In fact, the healthy ones that would have more flexibility to use those funds to take excessive risk -- rather than cover losses from bad loans -- eagerly repaid Troubled Asset Relief Program dollars over the summer. The large banks in the spotlight for still having TARP are even more eager to pay it back, due to what they see as micromanagement from regulators and excessive restrictions on pay and lending operations.

In this situation, banks actually want to get rid of bailout dollars to make profits.

Furthermore, making banks smaller will not discourage them from taking risks. If the housing crisis had occurred while a too-big-to-fail mandate had been in place, all the different businesses of a

JPMorgan Chase

(JPM) - Get Report

,

Bank of America

(BAC) - Get Report

,

Citigroup

(C) - Get Report

,

Wells Fargo

(WFC) - Get Report

,

Goldman Sachs

(GS) - Get Report

or

Morgan Stanley

(MS) - Get Report

would have been in trouble, because everyone from the borrower to the lender to the trader to the mortgage-security holder has suffered.

Instead, the government would have had to engineer a larger number of smaller bailouts, or failures, similar to the hundreds of small banks that are expected to have collapsed by the end of next year.

It's also worth noting that the government itself has been encouraging more risky lending behavior that banks are against.

Fannie Mae

(FNM)

and

Freddie Mac

(FRE)

offer an example of this, even before the bailouts of 2008.

Regulators and lawmakers have for years pushed Fannie Mae and Freddie Mac deeper into subprime lending in an effort to extend credit to poorer Americans who wanted to buy homes, but truly couldn't afford them. Those mortgage finance giants are now largely owned by taxpayers, and are still greasing the wheels of risky lending that their private counterparts would not touch without the implicit government guarantee they offer.

Another example of moral hazard exists in today's housing market. The Home Affordable Modification Program, or HAMP, combined with the

Federal Reserve's

policy of driving down interest rates to historic lows, has made loans a lot cheaper for Americans in a market where loans ought to be very expensive. The program was extended this week into 2010, renewing an $8,000 subsidy for new home buyers, and giving an additional $6,500 subsidy for existing home buyers to get into the market or refinance on the cheap.

At the same time, regulators are also putting pressure on banks to boost lending and modify existing loan terms -- housing, small business or otherwise. The Obama administration and lawmakers have also strong-armed banks into revising credit card and other bank fee policies to make them less burdensome for consumers. The Treasury Department has also begun releasing a list of mortgage servicers' loan-modifications each quarter to shame underperformers into adjusting more troubled loans.

The administration's goal is to simulate the economy and help Americans who are drowning in debt, which are both honorable and logical. But if moral hazard is a concern, these are prime examples of regulators incentivizing risky behavior for lenders and borrowers, while saying it worries of encouraging moral hazard for banks that are rushing to escape the bailout program.

Comparing the bailout program to moral hazard is a bit like saying the same for unemployment or other safety nets that exist for society. No one wants to be on the dole, but 9.8% of Americans who are able to work now receive unemployment checks, and millions more are eligible, but have given up in frustration. Many of them would prefer to be employed, but lack opportunity and need money to survive.

Similarly, banks came to the government out of necessity. The strict oversight and new regulations that have come with bailout funds seem to have disincentivized them from coming back for more.

--

Written by Lauren Tara LaCapra in New York.