The Dark Side of Personal Responsibility
I’ll admit it…I support personal responsibility. I don’t want to pay for the irresponsible actions of others. I want people to succeed or fail based on the merits of their actions.
It all makes me sound like a Republican, doesn’t it?
See, the problem with people being able to collect on success while not having to pay for failure is that it creates what’s called a “moral hazard”. People behave differently when they have little or nothing to lose, and much to gain.
Imagine if you could play blackjack, and got to collect all winnings, but only had to pay half of your losses. Suddenly, you’re doubling down on many more hands, and winning large sums of money. If you weren’t fully aware that half of your losses were covered by someone else, you might even conclude that you’re winning due to particularly clever behavior on your part, rather than due to the market distortion that arose from the protections.
Moral hazards create all sorts of destructive phenomena. Perhaps the most significant of the past decade came in the real estate boom, which was fueled by a whole series of moral hazards created at nearly every layer of the transaction. I’ll talk more about that in a future article.
For now, though, I’ll merely reiterate that I am very much in favor of people bearing the consequences of their decisions.
But we live in a society, which means that nobody bears those consequences alone.
As a simple example, let’s say that I bought a house in 2005. I had a good paying steady job, got a 30-year fixed mortgage with 20 percent down, and got a decent deal on the house. I did everything right, and by the book.
Through no fault of my own, a bunch of other people bought in the same neighborhood, getting 30-year five-and-one neg-am option ARMs with no money down. That’s where they get a mortgage that, for the first five years, allows them to pay less than the full interest payment, on a low teaser rate. After those five years are up, they have to pay as if it were a new 25-year adjustable rate mortgage, with monthly payments of both interest and a portion of the principal.
These other people were expecting to refinance at the end of the five years, getting a new mortgage similar to the old one. But they weren’t able to refinance, and suddenly found themselves unable to make the mortgage payments. And since they had negative amortization, they owed more on the house than it was worth. Since they couldn’t sell the house, they were forced to go into foreclosure.
A bunch of this happened in my neighborhood, which brought the value of my own home down to less than I had paid for it. Meanwhile, all of these people had less to spend, given their new mortgage situation, and so their reduced spending caused my employer to lay people off, including me.
I did everything right, and yet I’m being punished because other people didn’t do everything right. So my being responsible didn’t help me in the end.
Now, given that there is collateral damage caused by other people’s irresponsible behavior, what should be done about it?
And this is but one example.
We have the medical examples as well. Left to their own devices, many people tend to be medically underinsured or uninsured altogether. The odds are relatively slim that they will find themselves in need of medical care that they cannot afford, but a high deductible policy causes huge problems when they find themselves in need of paying for the big stuff. Do we let these people die because they rolled the dice and up came snake eyes? If we don’t, then we have already agreed to create a moral hazard.
We are left, then, with the following choices:
- leaving untreated those underinsured and uninsured citizens
- requiring everyone to be covered
- treating the underinsured and uninsured, and leaving the responsible people to pick up the tab
Prior to the PPACA, we chose option 3. As health care costs rose, an ever larger percentage of the population became underinsured or uninsured, driving up everyone else’s costs. Eliminating this moral hazard requires either everyone to be covered (option 2), or refusing treatment to the underinsured and uninsured (option 1). I far prefer option 2, which is close to the PPACA model.
And what about the other basics, like food and housing? Social safety nets like unemployment insurance extensions and welfare programs reduce the urgency of looking for work, but what do you do when there are fewer job openings than people who are looking for work? At some point, if there is enough of a gap between the number job openings and the number of people looking for work, the gap cannot be bridged by mere entrepreneurship.
Do we, in that case, choose to allow the unemployed to become homeless? If not, how do we avoid creating a situation where people are trapped in the social safety net?
Ultimately, it seems to me that we should avoid creating moral hazards, but also need to minimize collateral damage when catastrophe strikes. Focusing on either side without examining the other is a recipe for disaster.
For example, the failure of the Federal Savings and Loan Insurance Corporation (FSLIC) in the 1980s arose because the savings and loan institutions had their ultimate losses protected, which created a moral hazard that they exploited to invest in high-risk, high-reward real estate, much of it in Texas. When oil prices plummeted in 1986, the real estate market in Texas dropped just as suddenly, and the overleveraged savings and loans found themselves unable to cover the losses. Their customers didn’t lose their savings, but all of us had to pick up the tab through a federally funded bailout.
As I said, I believe in personal responsibility. But I believe that people need to bear all of their own responsibility. What I don’t want is the elimination of existing systems under the guise of increasing individual responsibility, while doing nothing to prevent extragovernmental systematic transference of responsibility to others.
In this regard, it is much like I had written about before regarding external costs. When one can push costs or risks onto external parties, it creates moral hazards within free markets.
So how do we prevent social collateral damage while similarly avoiding the exploitation of moral hazards? In other words, how to we ensure that personal responsibility cannot be avoided by intentionally passing risk onto others?
- The Big Design: Moral Hazard, and the EU (themarketsoul.com)
- Personal responsibility in promoting individual health (kevinmd.com)
- A Realistic Fix for the Mortgage Crisis (alternet.org)
- Analyzing the Popular Proposals for Mortgage Principal Writedowns, Part III (zerohedge.com)