Maybe “moral hazard” should be taken more literally

In this whole mortgage mess, the phrase “moral hazard” comes up an awful lot. When capitalism gets out of line, I think it’s always tempting for capitalists to look at incentives, say they reward bad behavior, and then focus thereafter on the incentives as the problem. But aren’t there always incentives for bad behavior? Isn’t that the whole point of cheating; because if it works it pays off?

Another common phrase these days is “incentivization,” an Orwellian neologism that implies the only thing keeping us from turning into complete savages and pillaging our neighbors is that we are otherwised directly compensated for not doing so. It’s a conceit of academic economists, I think, who hate the idea that there are aspects of a good society that can’t be understood with an equation.

The main problem with the mortgage debacle is pretty simple, even if the finances aren’t: some bad people cheated. There are ways to fight that, but not ways to guarantee it never happens. There is no system in the world that will eliminate every reward for bad behavior. The FNM managers probably broke laws and certainly violated their fiduciary responsibility, at the very least, but we’re to believe that the real problem was the moral hazard created by their implicit government backing? Chicken shit. The modern world is rife with moral hazard: we are almost never held accountable for our actions on behalf of others, and most of us work in situations where we are on the hook for very little of what is at stake. What ultimately keeps people from taking all manner of advantage of the myriad safety nets in our world (the GSEs are just an extreme example) is something that is not at all fashionable to discuss: morality. Not the religious pious type, but the social-minded morality that compells one to act honorably even if we haven’t been direcly incentivized to do so by some board of managers. Because cheating really does work out quite well for the individual who does the cheating.

These Wall Street crooks should be detested as pariahs, not seen as the inevitable victims of a poorly designed reward system. This is not to say we need no laws, or that incentives should be ignored, just that they are neccesarily but not at all sufficient conditions to a proper functioning society. Integrity cannot be regulated into people.

2 responses to “Maybe “moral hazard” should be taken more literally”

  1. Yes you’re probably wrong.
    It’s not true that cheating always pays off. If you have arranged the probability of detection and the corresponding punishment so that it doesn’t pay off in a given situation, you have reduced the risk of cheating in that situation.
    The solution you propose is unclear. If you want a system based on crooks being detested, that’s one form of punishment, just like the above, but difficult to achieve because you need to convert a large body of people to your particular religion (non-pious social mindedness which detests crooks).
    If you want people to be inherently less attracted to cheating, you have the same difficulty, although if you were successful in creating large-scale social-mindedness then the results would be dramatic. There is certainly an effect of social-mindedness but it is just hard to create via policy especially if the government is not able to use overt indoctrination programs.

    The fact that systems generate behavior via incentives and other forces doesn’t mean that you can’t blame people if you so wish, although it does undermine notions of blame based on free-will.

    (Here for your F# posts but got distracted!)

  2. Thanks for the interesting comment. I didn’t mean to propose any system, I simply wanted to point out that there is no system that will render all bad behavior unprofitable. How could there be? When I said people should hate these guys, I wasn’t suggesting that, in and of itself, would do anything material. I meant that the fact that we don’t is a symptom of why it happened. Namely, most people have no moral code. There is no system I know of that causes people to be honest. It’s a miracle anybody is honest, if you ask me.

    Are you suggesting there is some perfect set of laws that would actually lead to everybody acting morally, just because the set of rules makes it in their best interest through clever use of punishment and effective enforcement? I can’t believe that. There will always be people clever enough to screw with any system, and take advantage of others.

    I don’t think there is a system that will eliminate the possibility of people profiting from doing bad. My point was that if you quit fooling yourself into thinking otherwise, you can at least hope to mitigate the consequences of that fact. For one, we should quit wasting their time trying to come up with regulations and spend more time taking responsibility for looking out for ourselves. Caveat emptor has a lot more wisdom than people give it credit for. Second, honest people should quit trying to control everybody through laws, and realize that integrity is inexplicable, uncontrollable and priceless; instead of trying to induce it in others through the government, we should instead seek to form social and business circles of like-minded folks. Not a cure all, of course, but better than the false security of regulation and “correct inducements.”

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