The Invisible Hand: Episode Five – Moral Hazard

“What is a Moral Hazard? To economists, it is a state that exists when people tend to take more risks knowing that someone else will bear the costs.” [The Invisible Hand: Episode Five – Moral Hazard]

Couldn’t one say that this is the crux of what is wrong with our fetishism with unbridled capitalism? We glorify getting financially ahead of everyone else and tip a wink at the balcony when we do at the expense of others. We over-report our expenses or we under-report our income at tax time. Why do we do these things? I believe it’s because we perceive, rightly or wrongly, that the consequences of our actions will be borne by “someone” else.

I wrote about this awhile back in my blog post, Morality in Economics (And Elsewhere), from the perspective of how cheating increases when the consequences are abstract. You further remove yourself from the consequences of your actions, thereby increasing the likelihood that you will cheat at something, when those consequences are no longer directly your responsibility. This is especially true when that bearer of consequences is a large and faceless entity, like government or a corporation, or a derided segment of the population from your point of view, like the “snobby rich” or the “welfare scammers”.

Take the example of littering. Many people (even most people) wouldn’t think twice about tossing a gum wrapper or cigarette butt on the ground. These people likely think that “someone” will clean it up. They may justify it with the idea that they “pay taxes” and so some municipal organization will deal with it. As another example, I have also heard of a case of an elderly man who continued to buy large, inefficient cars because he “didn’t need to worry about the environment” as he would be dead long time before climate change would be an issue.

Specifically in this podcast, there is an excellent illustration of Moral Hazard in the recent example of the Sub-prime Mortgage Crisis. Lending organizations allowed people to take out mortgages from them even though they may not have the best credit history or sufficient income. They did this because they knew these questionable mortgages could be sold to a larger lending institution and the purchasing organization would bear the risk of default. In turn, these pools of mortgages would be bundled up and sold off to another institution as mortgage-backed securities. This cycle continued with investment institutions selling these securities to investors world-wide. As well, the cycle was accelerated by the lowering of interest rates and the loosening of criteria to qualify for a mortgage with the intention of boosting economic output. All these institutions made money on these transactions and when the original mortgage holders started to default, the largest of these investors began to go bankrupt. At this point the US government stepped in to inject tax dollars into these institutions as they were deemed “too big to fail”. These organizations knew the government would step in to save them so they continue down this questionable path. Of course, there are notable exceptions to these bail-outs (Lehman Brothers is a big one.).

I think it may be time to seriously consider that “Laissez-faire” economic policies don’t work in the perspective of serving the common good. We’ve seen widening gap between rich and poor across the world in industrialized economies as reducing so-called red tape has disproportionately benefited the very rich lessening the barriers to them collect massive amounts of wealth at the expense of the larger economic system. The predictions of trickle-down economics, that everyone would benefit if countries gave big business and the very rich large tax concessions, have just not panned out. Clearly, a more balanced approach is needed. Balance is difficult to achieve in a turbulent economic situation and requires constant work. This may be why politicians would prefer to pursue black-and-white solutions. They are easier to convey to the public and can be used more easily to garner votes. It does not have to be that way. The Nordic Countries seems to hit upon that balance though they also have their issues. It is high time that we, as a society, took a hard look at what has been tried economically over the last 100 years and determine what we did right and what we did wrong. It’s time to abandon moribund political doctrines of Right and Left. We need to look at what each side of the political divide has done well and incorporate these into something new because what we’re doing now isn’t working.

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