Thursday, September 25, 2008

A Moral Hazard Before It Even Happened

The Times has this new blog called "Economix." It's supposed to be about "the science of everyday life," which is already annoying to me, as if economics were the basic tool for explaining why people do what they do.

As I've discussed on C and C here before, economists cheerfully admit they have no idea why people do ordinary fun things like pay a lot for concert tickets, or why they feel compelled by fairness to pay for things even when it's not required, or why people vote.

Also the economic theory of rationality predicts that we all act in our own self-interest, which is just obviously false.

So while it's fine with me if they want to study money, the idea that economists are going to explain everyday life is just really, really irritating to me.

Anyway, over at one of their "guest posts" today, an economist named Bob McTeer explains that contrary to appearances, the bailout represents no risk of "moral hazard."

Moral hazard is when someone is rewarded for behaving badly or doing something dumb, and so is more likely to do it again next time rather than less.

The crux of McTeer's argument seems to be that since the individuals who made bad decisions actually will suffer consequences, there's no moral hazard. I'm not sure I've got all the details, but the idea seems to be that since the CEO's of AIG etc., are going to lose their jobs and money, the CEO's of the future won't be tempted into the bad behavior that got us into this mess.

CEO's, McTeer says, look at what happens to other CEO's, not to what happens to customers.

I don't know how this applies to the proposed bailout -- McTeer objects to the term "bailout" in any case -- but the basic idea seems to be that as long as you save the company but not its owners and managers, you don't risk moral hazard.

I'm no economist, but come on, really? Even before all this happened, lots of people were wondering at the planning skills of the people in charge. Lots of people were wondering, why on earth are these companies taking such enormous and dumb risks? It's not like no one knew something like this could happen.

One reason it must have seemed safe to take huge risks was because everyone else was taking huge risks. So you figure, well, we can't all go down in flames; the economy won't survive that. So there's safety in numbers.

Turns out that was right. Because we're going to bail these guys out. So the bailout created moral hazard before it even happened, just because we knew it was overwhelming likely that something like it would happen.

I'm not buying McTeer's argument that losing a job is the ultimate in motivating a CEO or bank manager to act one way rather than another. Anyway, anyone who *was* motivated by that sort of fear into behaving in ways that weren't taking big economic risks probably would have been fired before the crisis, for not bringing in enough money.

So the no moral hazard argument, I am not buying it.

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