Round and round

This excellent post from Don Boudreaux, reminded me of my less worthy attempt at this in 2012.

This is the dynamic in a nutshell:

1. In a freer health care market, the costs of being unhealthy or uninsured is borne by individuals. This provides strong incentives to stay healthy and insured.

2. In #1, some people will still fall through the cracks. Some because of bad choices they made, but others because of unfortunate circumstances.

3. Attempts to solve #2 that involve anything other than encouraging people to make better choices creates moral hazards* that cause even more people to take less responsibility for their health and not buy insurance. This increases costs for those who pay.

4. The same compassionate people who wanted to solve #2 try — with no apparent awareness of this — reproducing the natural incentives in #1 to stay healthy and insured by dictating both. This appears in mandates that sound like, If we’re paying for you health care, then we have the right to tell you how to live your life.

We already see evidence of this in New York City with bans on salt, trans fats and large, sugary drinks. New York was already well down the Obamacare path, which is why New York City was one of the first areas in the U.S. to show signs of #4.

Here’s an example from Japan. I see evidence of this starting here. My employer, for example, is now collecting my BMI and waist size and will soon want to start tracking my exercise activity.

Of course, the First Lady’s efforts to reduce childhood obesity are also initial steps in the direction of #4.

*Moral hazard – A moral hazard is created when some measure taken to reduce risks, increases the risks people are willing to take.

One example of this can be seen in football. Wearing helmets sounds like a logical safety measure, but has resulted in players hitting each other harder and even taking measures (like doping on steroids to build muscle mass) to hit ever harder.

The link to the post about the BMI penalties in Japan provides an example of moral hazard in medicine.

Democracy: Two Wolves and a Sheep Voting on What’s for Dinner

Responding to this post on Cafe Hayek, morganovich concisely sums up moral hazard:

why act responsibly if acting irresponsibly gets you free stuff?

He also concisely sums up the problem with government charity:

it’s always folks wanting to be generous with my money then voting themselves less skin in the game through purported defense of the “middle class” and its “unfair tax burden”.

10 years ago 24% of americans paid no net federal income tax.

that number is now 51%.

that’s a terrifying number as they are now the majority, so every time a new “compassion” issue comes up, a majority knows it’s not their money. it does not take a brilliant game theorist to see where that leads.

Well-said, even without proper capitalization.

The my-s**t-don’t-stink crisis

In his book, The Secret Knowledge, David Mamet gives a brief and apt explanation of the economic term moral hazard, which played a key role in causing the financial crisis.

This is from a footnote on page 187 (emphasis added):

Is it not evident that any organization believing itself to be “too big to fail,” will more likely, indeed, inevitably make disastrous decisions? Why should it not–it is Too Big to Fail.

We all know people who (and perhaps have experienced this of ourselves), at one time or another, began to believe that their own s**t did not stink.  And we all know how that story ended.  Not well.

Our last financial crises could be called the my-s**t-don’t-stink crisis.

Also, we should remember how those stories end whenever our “experts”, politicians and economists tell us that such-and-such an industry or company is too important and cannot be allowed to fail (though it usually already has, and few people recognize it yet).

Capitalism without losses is not capitalism

Economist Russ Roberts put forth the idea that the financial crisis was caused, in part, by moral hazard resulting from a history of taxpayer financed bank bailouts and the implicit taxpayer guarantees on mortgages that were manifested in  Fannie Mae and Freddie Mac.

Roberts’ white paper Gambling With Other People’s’ Money: How Perverted Incentives Caused the Financial Crisis was released last April.  This is from the Executive Summary of the white paper:

Over the last three decades, government policy has coddled creditors, reducing the risk they face from financing bad investments. Not surprisingly, this encouraged risky investments financed by borrowed money. The increasing use of debt mixed with housing policy, monetary policy, and tax policy crippled the housing market and the financial sector. Wall Street is not blameless in this debacle. It lobbied for the policy decisions that created the mess.

Roberts goes on to say that gambling with other people’s money is wrongly mistaken with capitalism and capitalism was then incorrectly blamed for the crisis.

I agree with Roberts, but I haven’t seen many who have shown outright support for his hypothesis.  It seems others believe the moral hazard link is tenuous at best.  However, now the Administration might agree, according to this Wall Street Journal editorial.  From the editorial:

The Administration puts the case for federal withdrawal from the broader housing market in compelling terms: “The strength of this option is that it would minimize distortions in capital allocation across sectors, reduce moral hazard in mortgage lending and drastically reduce direct taxpayer exposure to private lenders’ losses.”

I believe Roberts said it best when he said:

Capitalism is a profit and loss system.  Profits encourage risk-taking.  Losses encourage prudence.

If you reduce or limit the losses because you believe that helps someone (home buyers), you also reduce the prudence of the lenders and increase the risk-taking.  And you no longer have capitalism.

George Schultz on PBS

Frustrated with Tiger Woods banality on the major networks last night, I switched on PBS and caught a segment on the Lehrer News Hour with George Schultz discussing his belief that the financial crisis was due to the government creating a moral hazard with it’s ‘too big to fail’ bail-out nonsense.  He asks, if they’re too big to fail, why not make them smaller?  Great question.

I highly recommend watching the video.  Click here and it should be the first video listed on the left of the screen.

I nearly fell out of my chair.  Finally, some reason in media.  Good job Lehrer.  Getting warmer.

Moral hazard is the unintuitive lingo economists use to describe the idea that if someone or something is there to bail you out, you do things differently than you would if you didn’t have that backup.

If somebody knows they’ll be bailed out, they take excessive risks because they do it [take risks] on the taxpayers dollar.  The whole system is badly damaged when bailouts occur because it takes accountability out of the system and the market system depends on accountability, so we have to design a system so that anybody in it can fail.

The interviewer, who I hope was playing dumb for his audience (I think he was), asks Shultz if this is something he’s seen in the past or “is this a new phenomenon?”   This isn’t new.

This is everyday human behavior  that’s been around since the dawn of mankind.  If someone tells you they’ll pay for your retirement, you don’t save as much.  If you parents got you out of trouble when you were a kid, you got into more trouble.

Schultz explained two examples from the past to illustrate moral hazard.

First was a strike the longshoreman in 1968.  President Johnson enjoined the strike to prevent national emergency.  When Nixon took office and Schultz became his Secretary of Labor, another strike fired up, why not?  The President is going to help them get what we want to avoid a national emergency.

Schultz said Johnson was wrong and Nixon should stay out of it.  It would teach them “they have to take responsibility for their own actions,” kind of like the parent who finally learns they aren’t helping matters by soothing the temporary pain for the child who made a bad decision.  Nixon listened and the strikes died down.

Another example was with the failure Penn Central railroad.  The railroad grossly managed their affairs.  The Federal Reserve Chairman, Arthur Burns, wanted to give Penn Central a bailout to prevent a massive failure of the financial system.  Sound familiar?

In the end, he didn’t bail them out because they had retained Burns’ former law firm and a bailout would look too suspicious.  Penn Central failed.  There was no ripple effect.  The economy kept chugging.

While Schultz said a lot of good things in the interview, that wasn’t the part that fascinated me.  What fascinated me was that there was no yelling.  He wasn’t chastised for challenging today’s conventional wisdom that markets failed.  He was allowed to state his case and rationale in a calm manner and the interviewer tried to understand his points, rather than stuff him in the face with populist lay-ups.

I could imagine Matt Lauer conducting the same interview.  When Schultz said that staying out of the strikes would teach them they they need to take responsibility for their actions, I could envision Lauer cutting him off and asking him in his condescending tone something like, “but don’t you think the longshoremen need the muscle of the government behind them, because the companies have all the bargaining power?”  Or, “shouldn’t we have bailed out Penn Central?  X thousands lost their jobs.”

Then Lauer wouldn’t have given Schutlz a chance to explain that the end result of the actions that weren’t taken were far away better than what would have happened after the temporary soothing of the government action, much like the parent who finally decides its time for their kids to learn a lesson.