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Saturday, September 08, 2007

Reich on Moral Hazard

by Tanta on 9/08/2007 04:18:00 PM

From Robert Reich's blog (Hat tip, Yves):

One day while sitting on a beach last summer I overheard a father tussle with his young son about whether the child was old enough to take out a small sailboat. The father finally relented. "Go ahead, but I’m not gonna save you," he said, picking up his newspaper. A while later, the sailboat tipped over and the child began yelling for help, but father didn’t budge. When the kid sounded desperate I put down my book, walked over to the man, and delicately told him his son was in trouble. "That’s okay," he said. "That boy’s gonna learn a lesson he’ll never forget." I walked down the beach to notify a lifeguard, who promptly went into action.
Reich has some interesting comments on our rather different treatment of risk-taking by corporations and risk-taking by individuals. The whole thing is worth reading.

I am increasingly troubled by a take on the "moral hazard" problem that sounds to me, ultimately, like a kind of moral extortion. This is the old argument (it has been used before now against any "safety net" provision) that nothing will stop people who are not "needy" from finding a loophole through which to exploit the safety net, and therefore it will have unintended negative consequences. So we should not offer it at all, because while the needy will be helped, the unneedy will also be helped, and this, the argument goes, is an unacceptable outcome.

What this is, of course, is a threat, not a prediction: a way of threatening to make us end up with a politically unpopular "free rider" program by promising to free ride on it before it gets started. It seems quite clear to me that the argument really isn't about "moral hazard," since in order for it to be about preventing hazards there has to be, as Reich notes, a much clearer ability for people to assess certain risks. In other words, the more sophisticated, informed, and powerful the risk-taker, the larger the moral hazard, because that risk-taker can both see the risk and see the potential bailout, which may not be all that obvious to the less well-informed. (Just ask your average homeowner if he or she sees FOMC minutes as a potential backstop against the risk of taking out a home equity loan. You might have to explain what FOMC is first.)

Would I call the lifeguard if I saw a parent apparently willing to let a child drown in order to "teach that kid a lesson"? Yes, and then I might call the police next. It seems to me that there is a certain hazard to that kind of morality.

Is it a useful analogy for the mortgage mess? Well, insofar as lenders should be expected to know more than borrowers do, and thus exercise some reasonable restraint in making loans, then, yes. On the other hand, infantilizing other adults is rarely helpful, in my view. The parent-child analogy gets you bogged down in worries over "paternalism" or "nanny state regulations" that, I think, have more emotional than rational content.

Even worse, though, this analogy calls to mind the infuriating comment Angelo Mozilo--the Tanster himself--made a while back about high-risk lending:
"First-time home buyers were begging us to make them loans because they thought home values were going up significantly, and so they put a lot of pressure on us to make them loans," he said.
Yes, we lenders are just long-suffering parents who finally succumbed to those wheedling, whining children who pestered us until we gave in. Now, the children should blame themselves for their predicament. Sure.

Strangely enough, Countrywide has not yet erased from the web this 2003 presentation, by one Angelo Mozilo, on Countrywide's "mission" to provide "outreach" to first-time homebuyers, with low-downpayment mortgages and flexible underwriting guidelines. I don't know about you all, but I've always thought "missionaries" were the sort who brought their gospel to the heathens, not the ones who were forced to re-write their gospels in the face of intense heathen-lobbying. The very concept of "outreach" implies that they are inhibited from coming to you, so you must go to them. It works well in drug-abuse interventions. It appears to have a possible problem when you apply it to mortgage lending.

Letting "them" founder, in my view, is not "tough love." It's self-serving rhetoric designed to retrospectively shift the real "risky behavior" onto those of whom advantage has been taken, so that they become the ones who need to be "punished" to remove the "moral hazard." I think it's a rhetorical trick that we could usefully resist.