We’re hearing a lot about “moral hazard” in the news these days.
In policy terms, “moral hazard” is a situation when laws or policies encourage people to engage in risky behavior, knowing they will be insulated from bearing the full cost of their bad decisions.
It creates a moral hazard, for instance, for the government to bail out investors who invested in high-risk instruments, such as subprime mortgages, when their investments go down the tubes. This practice encourages people to engage in more risky behavior than they otherwise would if they anticipated that they would have to bear the full risk themselves.
Another example of moral hazard is federal flood insurance, which will allow someone to build in a risky area, such as a coastline, knowing that if the worst case scenario happens, the government has already bailed them out by providing low-cost (subsidized) flood insurance.
It is obviously unfair to taxpayers who can’t afford a beach house to take their money and use it to subsidize flood insurance for people with beach houses. And it’s unfair to inflate the entire U.S. economy to protect the bonuses of politically connected Wall Street investment bankers whose subprime bets didn’t pay off.
But what about the impact on those who receive the bailout? What does it teach them? And what about the impact on those who observe the moral hazard and learn the (wrong) lesson?
Increasingly, it seems, poor government policy is creating moral hazards by insulating people from the possible risks of their decisions.
Former Colorado State University Professor Duane Hill has studied weather disasters for decades in the southern and western U.S. and was amazed at how prevalent the tendency was for people to ignore the looming threat of natural disaster.
But the worst part of it all was their expectation that the government would bail them out when the inevitable occurs.
It’s clear that moral hazard is having an impact on the decisions made by participants in the U.S. economy.
We shouldn’t be handing out federal taxpayer dollars to be spent on rebuilding in areas where the vulnerability to extreme weather is particularly high.
We should also work for changes in our insurance industry that will allow the industry to better and more accurately price risk in our society, so that the insurance costs of risky behavior will more fully inform peoples’ decisions.
But, most important of all, we need to avoid the creation of a culture where the decision-making skills of the American people are gradually eroded by insulating them from the risks inherent in any decision.