Friday, February 27, 2009

Moral hazard

James Surowiecki is a New Yorker writer best known for his book, The Wisdom of Crowds. This book, which I concede I haven't read (only excerpts), is notable for the way its message quickly spread through the landscape. Essentially, Surowiecki contends that groups of people have abilities to make decisions that far exceed what any organized effort could do.

He went into some detail as to the conditions that would allow this to happen; of course, as the idea became popularized, it became oversimplified, to the point where his work was cited as confirmation of the "The market is always right" dictum. From what I've read, his argument is far more subtle and detailed than that. (Does it suggest something that the wisdom of the crowds is lacking when it came to understanding of the message of The Wisdom of Crowds?)

Andrew Sullivan directs us to a Surowiecki post in The New Yorker that confounds with its lack of insight. He writes about moral hazard, the idea that we will, through our current policies, encourage bad behavior:
[T]his is a very odd time to be worrying about people taking too much risk. In fact, as he writes, the problem we’re facing right now is “too little risktaking, not too much.” People are so understandably worried about their jobs, their savings, and so on, that they’ve become far more risk averse than they normally would be. Bailouts may make people a little more likely to take a gamble. But at the moment, that’s precisely what the economy needs.
Can he really not understand that the fears of moral hazard do not involve actions of today or tomorrow, but of the future? We've become a nation of real estate speculators, stock pickers, and lottery players, and the current crisis demonstrates that we are finally paying the price for our wanton disregard for prudence. And Surowiecki wants us to encourage the very behavior that got us into this mess.

Moral hazard is pretty simple to understand. It involves the providing of external incentives for behavior that, taken on its own, would be intolerably risky. Should you buy a house you can't afford? Normally, anyone would say no, but, if you have a promise of a bailout should you get in over your head, the terms change, and it will be a go decision. A lot of people would walk a tightrope only if there was a net below; that doesn't make it the responsibility of the rest of us to provide that net.

And that's where moral hazard has its force. We are demanding that the people who were prudent take a portion of what little they have left and subsidize those who were reckless. In doing so, we encourage them to be even more reckless the next time around, because they know we'll be there for them.

Surowiecki is a smart enough writer to understand that, so I don't know where he's coming from in this piece. What next, a federal program to give slot machine vouchers to every American so we can get our economy gambling again?

What we need to do is figure out what our economy will look like in 5 or 10 years, and take the steps now to get us there - not reheat the bubble economies of the last decade that have led to amazingly little fundamental advancement in our standard of living.

2 comments:

Greg Glockner said...

We covered this earlier this week on the Dwaffler blog. We've established a precedent that you don't have to be careful because the government will jump in and give you taxpayer money if you fail. And it will probably make us weaker in the long run.

I know that desperate times call for desperate measures, but this is rewarding bad behavior.

Anonymous said...

In the end, the government is not punisher of bad behavior when the consequences are so dire. No, the government must fix the situation while also addressing the behavior. Would ten years of falling GDP be the proper sort of consequence? How could you justify that to the generation that suffers? No, you must instead prevent a repeat, and not by enforcing mass-suffering. In fact you'd induce a generation hell-bend on overly-high savings rates, when in fact we need "just right" savings rates, not this boom-and-bust cycle! You people analyze this like you're a mom, not an economist. Moral hazard is so seductive to sanctimonious bloggers! Weaker in the long run? TEN YEARS OF DECLINING GDP makes us *much* weaker in the long run!!! ugh. such a seductive line of reasoning, with such grand overtones of moral rectitude and judgement, and so clearly mistaken.

And just wake up and acknowledge that there is no bailout for underwater mortgages. Just acknowledge it. And banks are, with regrettable inconsistency, still giving up major equity positions for the government's help. So they'll think the government will save them? The government IS them for the time being.

mcfnord

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