Moral Hazards

One term that keeps popping up in discussions of the finance bailout (e.g., John Stossel a couple of weeks ago and in the WaPo this morning) is "moral hazard". The term has also been referred to in debates about health insurance. But you probably haven't heard a good definition of what the words actually mean.


The term dates back to the 1600s and was widely used in the British insurance industry by the 1800s. Wikipedia defines it as a special case of information asymmetry -- the advantage that goes to a party who has more information than the counterparty being negotiated with. In this sense, the moral hazard arises in that if one has special or inside information he will be tempted to use that information to "game" the transaction. At bottom is probably the idea that he would be a fool not to do so, and so the hazard or asymmetry must be identified and mitigated before the transaction is final.


In the current debate, commentators on the right, like Stossel, are appealing to another sense of "moral," in the sense that it is immoral not to properly punish a bad decision or mismanagement. Just like we make sure a house fire is an accident before putting it out, and lifeguards make sure the swimmer didn't just decide to venture too far out, and ER doctors first decide who's wrong or right before treating a gunshot. Oh, right. That's not the way life works in this modern, western, judeo-christian culture. Correction and improvement is one thing;  punishment is something else entirely.


This is not just abstract, soft-headed charity, agape or eros. We have learned, through many hard lessons, that a neighbor's fire can burn our house, no matter who started it. It used to be that if you hadn't bought insurance from the fire fighters, your house was going to burn, no matter who started it. As a society we decided the price was too high -- to everybody.


In the last few years, there are some individuals, mostly but not entirely on the right, who have argued there is a moral hazard inherent in robust health care insurance -- people will use too much of it. If health care is too cheap, they'll just go running to the doctor for any frivolous reason at all. It doesn't matter that real life doesn't support this psychological tale; it was a textbook example of moral hazard, as defined by health insurers. And it was their argument for making the system difficult and mean: "We are removing the moral hazard for their own moral good. (And our profits.)"


So let us return to the failure and bailout of the financial sector of the economy. It is ironic to me that the system, again largely defined and sold by the right but support by key characters on the left, actually installed moral hazard in the system more than 30 years by assuring information asymmetry in the system itself. The key reason for removing oversight of banks and brokerages was that they -- the finance pros -- knew best, only they had the info to make the best choices and make the market work at its optimal efficiency. Left to these wise men, the market would just take care of itself. And I'm not even talking about quants! (Some other time, perhaps.)


This gospel was largely preached by the so-called Chicago School economists. The neoclassical offspring of von Hayek and Friedman, they believed they understood how to insure efficient markets. They leveraged a uniquely adolescent understanding of the world (Rand-ian objectivism/libertarianism) into an economic theory that valued concise measurements and simple predictive models, predicated on (universal) rational self-interest. They have stood astride the global economy of the last three or four decades convinced of the perfectibility of their models, and look how well it's worked! 


Former Fed chief Paul Greenspan (a youthful acolyte of Ayn Rand's) rode his absolute conviction about the ultimate aim of economy's arrow right to the ground and only expressed mild chagrin that he hadn't -- that the industry hadn't -- foreseen the role of inefficient greed and self-destructive ambition. He still doesn't have his head around that. Who is John Galt, indeed.


When they talk to themselves, the right seems to be pretty comfortable trotting out "moral" issues. But what can be said about the morality of letting others suffer -- in terms of under- and un-employment, inadequate and uneven health care, a growing disparity between wealthy elites and not-quite-making-it proles -- while preaching moral hazard? Even if you don't actually say "Let them eat brioche?"

Our American character

What is it about the "American character" that allows the kind of looney-tunes debate now taking place around our attempts create a rational health care system? 

This debate goes back to the beginnings of modern medicine, which came at a price. The first insurance companies, in the thirties, were more like philanthropic organizations for groups like the Elks. It was the fixed wages of WWII  that made employer-supplied insurance a way for GM and others to attract needed workers. 

President Truman tried to deliver universal health care as a natural extension of Roosevelt's "Four Freedoms," but a resurgent Republican party branded the policy, and him, as "communist." And it certainly helped that once the big employers realized how big that pool of insurance money was, there was no way they were going to give it up.

After decades of health care under this model we have a body of evidence that's pretty hard to ignore -- unless you want to. Consider:

• We are the only industrialized country in the world without a universal public health system (link).
• We pay almost twice as much per capita for the care we do get,
• Spend a much lager percentage of GDP,
• And our life expectancy is towards the bottom of the pack (link)
• Last year, in more that 62% of US bankruptcies, medical bills were the main cause, 
• And most of those people had life insurance (link)

And it's not as if this information is difficult to find. A few minutes with Google will give you hundreds of studies and sources that tell the same story.


Even more confounding, as reported by Robert Creamer,  "a poll conducted for Americans United for Change by the respected firm of Anzelone and Liszt -- completed last Friday -- shows that, by a 62% to 28% margin, likely 2010 voters would be more inclined to support President Obama's healthcare reform plan if it included a public option that gave people a choice between private insurance plans and a public health insurance plan."

An excellent piece in Slate by Timothy Noah, "A Short History of Health Care," makes the observation there is are two realities in this discussion: 

"The trouble with the policy debate that's slowly beginning to emerge as the medical-industrial complex spins out of control is that it pays maximum deference to Reality 2 (political reality) and minimum deference to Reality 1 (the thing itself). "

The take-away is that our legislative system is not, in itself, democratic. Specifically, the Senate's function is to blunt the voice of the people. It was formed to protect the interests of the large land-owners (who were also largely slave owners at the time). In the past few decades the Senate has been also become the guardian of the large corporate interests, and there is almost no corporate interest larger than the alliance of insurers and pharma. The fact is that a relatively small number of Senators can effectively block any action that threatens their corporate allies. Rep. Jim Wilson (a protegee of Strom Thurmond) calls the President a liar and immediately raises a half million dollars (which is about what he received the last few years from insurance companies).

Add to that a few entertainers who see an opportunity to build an audience, and have no compunction to ignore the factual evidence, and you can motivate a few thousand disgruntled (if not exactly unified) partisans to assemble and grab a few minutes in the media spotlight.

The fact is there are many people unhappy with the political process. From the left side of the spectrum we it looks like our modern Know-Nothing, troglodyte party is about to take down the one chance we may have to  create a rational health care system. But it ain't over yet.

For one thing, the American character may not be patient. It may want instant decisions, and not much palaver. We want the 80-yard touchdown play. Every time. But it seems we have a specific character in the White House who is comfortable enough with the reality of the thing as it is that he's willing to outwait the opposition, to stay with a strategy that is realistic about strengths and weaknesses and the critical importance of this opportunity.

It just might be that because of a singular American character, history, and time, is on our side.