Moral Hazard

Recently a friend of mine told me that – “he didn’t care what they (government) did, they should just fix it (the economy)”.

I was amazed at his conviction that “they” could fix “it”.

When I was in school – one of the dominant right wing political parties in India was trying to alter History textbooks to show a certain historic incident in positive light.

That became a huge controversy and I was really peeved at the – Historians for not telling “History”, as it is. It is much later that I realized that there is no History, as it is. It is the reconstruction of past events and is full of human biases.

I am fairly certain that my friend too will someday realize that no one has any certain answers to fix the economy, only opinions; but that will take time.

They Should Fix It

The real import of this statement hit home much later in the day.  My friend viewed the recession as a problem created by someone else and which needed to be solved by someone else.

I am fairly certain that all the bailout packages – whether banks or homeowners, have at least one side effect for sure, and that is – Moral Hazard.

Moral Hazard is when someone knows that they will be safeguarded from a certain risk, and therefore they alter their behavior.

For example, If homeowners know that the government will bail them out if home prices fall, they will take on more risk than they would have otherwise taken.

Similarly, banks who know that they are “too big to fail” will take more risks than they can handle, because they know that if something goes wrong the government will have to bail them out.

When the CEOs of the car companies first asked to be bailed out, they basically said – bail us out or the whole industry will collapse.

I am fairly certain that no one took the taxpayers hostage in such a way at any time other than the current recession. It is creating a – Moral Hazard so big that it may end up pervading the consciousness of a whole generation, who may learn that it is okay to make mistakes as long as every one else makes the same mistakes.

That can’t be the foundation of a healthy society, but some would argue that – hey, you need the bailouts to have any form of society to start with.

Will We Remember?

I think that despite the good intentions and nobility of all involved, the current approach is going to fail. The question is how many people will remember that the current approach failed when the next recession comes up?

The housing bubble was not the first bubble and it certainly is not the last bust. Something tells me we will not learn from this chapter of history, but then I guess that is just how humans are wired and there is nothing we can do about it.

13 thoughts on “Moral Hazard”

  1. Imani,

    A six month ban on all Chinese toys without any corresponding demands to improve safety standards will certainly not offer any long term solutions. What will happen after six months?

    However China’s southern province – Guangdong, which was called the toy capital of the world till recently, and which has shrunk to half its original size due to reduction in exports – will certainly feel the heat of the Indian ban.

    So to that extent – I think India has made the point it wanted to make.

    P.S. – Feel free to use HELL here, there is no editing going on in here.

  2. Manshu, So, do you think India made a mistake banning Chinese toys? Who knows what chemicals are in the wooden toys? I don’t have young children anymore, but I surely wouldn’t buy a piece of toilet paper from China.

    About Pakistan giving China responsibility for negotiations between Pakistan and India over the Mumbai bombings…I admit to ignorance here.

    The bombings and other goings on in Mumbai were horrific! From what I read (maybe it was all fantasy) the bombers/attackers were from Pakistan. I watched those events in horror just as I watched, in horror, the events in London, Spain, and in the US on September 11. What the H*LL is going on??? We live on a tiny planet, in a small solar system, one of many millions.

    My personal opinion is that Pakistan is not doing enough to stem the tide of terror emanating from within its borders. Not sure why.

    Sorry if I am off-topic here.

    Thanks again for your blog and for the opportunity to express my opinion.


  3. Manshu – The only television I watch is online or on DVD’s so I didn’t see those ads – I’m sure I would have been appalled.

  4. This is one of the things I worry about most with all of the government “bailout” strategies. Bailout implies companies and people not being held accountable for their actions. A lot of companies and a lot of people have taken advantage of great markets and easy credit for a long time. Half of me wants the government to just let things fail that would naturally fail. The other half can definitely see why we wouldn’t want national banks and industry giants to go down. Lots of casualties.

    The sad part is that we’re not even sure the bailouts will end up working, so in the end, we might have spent a couple of trillion dollars to keep a sinking boat afloat for just a little more time.

    Or, it could work. Which is all of our hope.

    1. FrugalCPA,

      I sure do agree with you. In fact now that I have seen ads that proclaim to get you money from the government, without having to repay it – I am tipped against bailouts of any kind or form.

  5. Imani, Its just that they even banned wooden toys! And I think the Chinese now control about 70% of the Indian toy market.

    But what’s really interesting is that the ban came just a few days after Pakistan announced that it gives a – Carte Blanche to China to negotiate on its behalf with India on the Mumbai blasts.

    Could that have anything to do with this? I wonder 🙂

    Anyway back to the point in this post – I really wanted to say what Kim said in a later comment, about this being a part of human nature, more than anything else.

    Thanks for your comment Imani, it really did bring out a new dimension on this post.

  6. Manshu, If India banned Chinese toys, it was a good move to protect the children of India.

    Did you not read about the dangers of the those toys containing way too high levels of lead?

    How about the melamine in baby formula in China?

    We may differ in opinions, and that is OK because it makes the discourse more interesting, and I can even change opinion given the right information.

    But I don’t think protecting one’s children against known dangers is equal to protectionism.

    Peace, and thanks for your insightful blog…


    P.S. Still planning that eye-fluttering request for a modest discount :-).

  7. Kim,

    Did you see those ads which said – “Let me show you how you can take $12000 from the government and not repay it”

    It made me scream when I saw that!

  8. This is a really good point. Though people are taking a risk in assuming that they will be bailed out just because they were before. I suppose it’s the same risk they took in buying a house they really couldn’t afford because they were given a mortgage for it.

    I don’t think lack of personal responsibility is a new thing though – I think it’s part of human nature. People who are more self-aware accept that they are responsible for themselves but many people never do.

  9. Miss M,

    Thanks for visiting and commenting. The whole world is getting more protectionist with India banning Chinese toys and such. It is getting worse.

  10. Sadly personal responsibility left this country some time ago. Even the people responsible feel they are due a bailout, the ‘not my fault’ mentality is pretty pervasive. This makes your moral hazard scenario more likely to happen. I’m not sure when it started or how we got to this point.

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