Moral Hazard: A Tempest-Tossed Idea

by Shaila Dewan

New York Times
February 25, 2012

The reports outraged America: In the wake of Hurricane Katrina, people who fled the ravaged Gulf Coast were spending disaster relief, paid for by taxpayers, on tattoos, $800 handbags and trips to topless bars.

It turned out that few, if any, Katrina evacuees actually did any such thing. A vast majority used debit cards issued by FEMA to buy necessities like food and clothing. But the damage was done: FEMA swore that it would never hand out money like that again.

Behind this brouhaha was an idea that Americans seem particularly preoccupied with. It is called “moral hazard” — an obscure insurance term that has taken on new currency in our troubled economy. We’ve heard a lot about moral hazard lately, first in connection with the bailouts for big banks, and now with efforts to help homeowners who got in over their heads.

Moral hazard sounds like the name of a video game set in a bordello, but in economic terms it refers to the undue risks that people are apt to take if they don’t have to bear the consequences. In other words, if the money is free, why not spend it on a designer purse? If you know that you’ll be bailed out, why not roll the dice on some tricky mortgage investments — or splurge on a home that you can’t really afford?

Moral hazard became part of the national conversation in the financial crisis of 2008, when ordinary Americans wondered why they should rescue banks that helped drive the economy off a cliff. Now those same banks point to moral hazard to explain why they can’t do more to help people with mortgages. And it’s not just banks — the Tea Party movement was inspired by outrage over a government plan to, as Rick Santelli put it in a famous rant on CNBC, “subsidize the losers’ mortgages.”

The cherished American ideal of self-reliance has a flip side: discomfort with the idea of bailouts and safety nets. The notion that even a small portion of such aid might find its way to the undeserving can be enough to scuttle support, or restrict help so drastically that few can use it. The specter of moral hazard haunts a basic tension in American life: to what extent are people responsible for their own problems? The more trouble you’re in, moral hazard suggests, the less we should help.

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