Moral Hazard – It’s not Just for Individuals Anymore

“A worker’s appetite works for him, his mouth urges him on” – Prov 16:26

There are quite a few definitions of “moral hazard” out there, depending on how economically wonkish you want to get. One of the cleanest ones I’ve found is this: “the tendency of people who are insured against a specific hazard to cease to exercise caution to avoid the hazard.” (This, of course, isn’t all-encompassing. There are aspects of moral hazard that pertain to immoral motivations and risk protections in contractual agreements – but this isn’t a wonk blog.)

We heard a great uproar back during the 2008 TARP bailout of mortgage-backed securities. This presented moral hazard on two fronts. First, banks made bad loans, taking unwise risks and were then shielded from the negative consequences of those risks by the US taxpayer. Further, homebuyers who took unwise risks in buying houses that were too expensive for them had their consequences lessened as well. (This later one didn’t fully materialize in practice – homeowners still got shellacked.)

Developing or promoting such moral hazards bespeaks a rather severe lack of understanding of personal behavior. As a fundamental, you must believe that people are rational. They may not be brilliant, or informed, or wise – but they are rational. They do understand cause and effect and consequences, and they have an ability to make judgments regarding what is in their best interest. Lenders who know that losses will be bailed out by the taxpayer will gladly make stupid loans. Buyers who know that they won’t get stuck with the bill will gladly buy more house than they can afford. Able-bodied people who know that food will show up on their doorstep (and cell-phones and cable TV) even if they do nothing, will gladly take the free ride.

We’ve known about moral hazard for individuals for some time. We see it in state actions as well. (I would argue that continual UN haranguing of Israel over its victories and gains in various arab-israeli wars presents moral hazard. Why stop attacking if there are no consequences? Of course, that isn’t the point of this post.)

Our point here is in regards to state budget management. When the federal government makes promises it can’t possibly keep, it just prints more money, effectively taxing the next generation without their knowledge (shame on you federal government … and supporters). When states do the same, they have to convince somebody to loan them the money – which get’s harder as the debts pile up. Lenders begin to wonder if they’ll ever get paid back (they won’t) so they stop lending. This leaves states in an awful pickle. Do we raise taxes in the face of a recession or do we cut services? The state’s have chosen the third way. Why not just ask for a federal bailout?

Last month a $23 billion bailout of education failed to pass. (Before you balk, the bailout of the education system was no more than a bailout of over-promised benefits packages and the desire to not layoff any teachers even though we can’t afford to pay them.) Now president Obama is asking for $50 billion in emergency funds to help state and local governments facing shortfalls.

Sooner or later it has to stop. You can’t let state governments make horribly bad financial decisions and face no consequences. They have to either raise taxes or cut spending – and face the wrath of voters. Continual development of moral hazard will not lead to a more prosperous tomorrow. Quite the contrary. It is rational decisions of individuals (and even corporations and governments) that leads to better allocation of resources and a more prosperous economy. Moral hazard is exactly the wrong direction to take.

The Bible is clear on this front in regards to personal work ethic (2 Thes 3:10). We cannot, we should not, as people of faith continue to support these ultimately destructive policies. Yes, there will be a great wail and cry from affected quarters – there always is. Sometimes doing the right thing is uncomfortable.

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