Wednesday, February 29, 2012

Is "Moral Hazard" a Myth?

This was actually addressed (and answered in the affirmative) in a 2005 piece in The New Yorker, titled “The Moral Hazard Myth,” in which author Malcolm Gladwell noted that people with health insurance don't go into hospitals for their enjoyment (unless maybe they are One percenters in the "amenities units"), and that people without medical insurance often forgo preventive care that could save thousands of dollars. So how is that "moral hazard"?

Conveniently, when the pundits and elites bloviate about moral hazard, they overlook the noneconomic costs of risky actions like smoking, e.g. costs from lung cancer, the attendant suffering and death. Nor is gobbling giant burgers and fries every day (or even once every week) at Mickey D's deemed a "moral hazard". We are informed instead by the pundits that to try to regulate such behaviors is tantamount to intrusion by a "Nanny state", never mind our costs from obesity and diabetes will soon bannkrupt us if our military overstretch doesn't!

One law professor at the University of Pennsylvania, a Tom Baker, once wrote a historical account (1996) entitled On the Genealogy of Moral Hazard,” that: “Moral hazard signifies the perverse consequences of well-intentioned efforts to share the burdens of life, and it also helps deny that refusing to share those burdens is mean-spirited or self-interested.”

Again, convenient. But the question that occurs is why is this attribution and designation so selective? Tending to focus on the missteps, benefits or foibles of ordinary people as opposed to those of hedge funds, giant banks or bankers? Notably here, Baker also adds (ibid.):

"The economics of moral hazard work to convince us that, however well intentioned, social responsibility is a bad thing,”

Now where have we seen this before? Give up? It is in Vilfredo Pareto's Pareto distribution. See, e.g.


As noted in the top-linked blog, at the heart of "Pareto efficiency" is what's called the reservation price for a given object or service. This is just the maximum price a person is willing to pay. (Or more often, can pay....given financial circumstances!)

Example: say a new apartment complex opens up and is selling apts. (1-3 bedrooms) ranging from $1,500/month (for single Bdr) to $2,400 for 2 Bdr, to $3,600, and people want to buy. Obviously, a relatively poorer couple will have a reservation price probably lower (e.g. $1,000) than any of the apartments, and hence need a Section 8 HUD rental subsidy to offset costs, while the rich couples or families can move into any of them.

But, according to modern economics and the Pareto distribution, offering a rent subsidy on the order of $1,000 (for the single Bdr apt.) effectivly removes it from the actual competitive market . Because this exerts a price below reservation, though offering the apt IS sociall responsible, the Pareto economist regards it as "moral hazard".

This is exactly where and how the discussion was evolved to reject any economic actions that confer such social responsibility, because it is believed the recipients will not then exercise self- initiative and instead become dependent on "government handouts". The same arguments are often used against providing food stamps for any length of time. People - never mind jobs are unavailable- become too dependent on them and get "addicted" to handouts.

Thus, to these economists, "moral hazard" came to be equated with "Pareto inefficient".

Obviously, this was also the basis for Fed Chairman Alan Greenspan going on record in an appearance before congress (in 2003) and asserting that "Social Security benefits need to be cut to pay for Bush’s tax cuts." Social Security payments, especially with COLAs, do everything the Fed Chairman detested. They poured more money into the economy, but not via productive labor or market indices, or investment returns. People received their checks on the basis of a social insurtance contract....thus, merely by existing and breathing day to day, and having paid into the system with FICA deductions.

In effect, providing Social Security benefits, especially with COLAs that kept pace with inflation, was a "moral hazard". Socially responsible, yes, okay. But a hazard morally because those elderly people were now making haste to collect on the government dime (often as soon as they hit 62) instead of getting their butts out there and working longer ....earning on their own. (Never mind most employers won't hire them ...other than maybe as Walmart greeters!)

What about health insurance? Let's say the productive cost of the typical primary care physician's visit is $150. This is what she charges, or what her Affiliated Primary Care center does. The non-wealthy person (having shelled out $250 for an insurance deductible) is then happy to pay only $15 for a co-pay. But this "skews the system" and makes it Pareto INEFFICIENT while introducing "moral hazard" - because the patient will then likely come to underestimate ongoing real medical expenses.

If one therefore takes the difference ($150 - $15 = $135) it makes more sense to just give the unwealthy person say $134 NOT to visit the doctor and consume resources. This then, also avoids feeding the moral hazard. With Medicare and Medicaid it's even worse, because the moral hazard -Pareto poppets argue that medical services are even more undervalued by those government-served populations.

I noted as a special example getting a preventive test, like a colonoscopy which normally would run $3,500. But there's no way the insured regular patient can afford that total cost, most of which his or her insurance picks up. Meanwhile, calculations- based on Pareto Efficiency- show if the insurance paid part is $2,000 (while the patient's reservation price is $1.500) it makes more sense to give the prospective testee $1,499 NOT to get the colonoscopy, than to let her get the test and consume valuable specialist time and resources via $2,000 subsidy.

Their argument is that not getting the colonoscopy avoids moral hazard! (Never mind that if the patient then gets colon cancer much larger health costs will be imposed on the system)

In effect, to grasp the reasons for selective assignment of "moral hazard" in our society it is important to grasp the perverted basis of our economic system which rests on Pareto's distribution. This basis will always disfavor social benefit or social responsibility, when lined up against economic advantage.

The obverse is that the true villains who unjustly profit and display real moral hazard, get away with murder. Thus with the S&L crisis in 1989, massive public bailouts were made. Private entities collected massive public rewards. Same with the bailout of Long Term Capital Management in 1997, and more recently, AIG and the banks in 2008. The latter, especially, were guilty of using public money - put into the banks on trust - to speculate in the securities markets via credit default swaps. (See the movie, 'Inside Job', if you haven't already!)

According to Elyse D. Cherry, the C.E.O. of a community development group, Boston Community Capital, "moral hazard is hogwash.” Why would she say such a thing given her company is putatively a live laboratory for active moral hazard? (It buys homes that have gone into foreclosure, then sells them back to the original owner at a price they can afford).

Her response is insightful and discloses she can see through the moral hazard smokescreen and rubbish of the Elites and realize that people aren't just toddling toward endless and limitless benefits! Thus, the ruined credit of milliions - say who declare personal bankruptcy- makes it harder to borrow money, or get an apartment. Moreover, given nosy employers are increasingly doing credit checks on prospective hires, it makes it damnably difficult to find a job to escape their existing economic morass. Meanwhile, to even search for a job in greener pastures far away is hard on families because they may not be able to get the selling price they need for a home ...and moving is often a logistical and timing nightmare. Then there are the larger social costs when desperate people - like the subprime mortgage purchasers in 2007-08 - aren't assisted: pockmarked neighborhoods and declining property values.

So, in effect, while using the moral hazard PR weapon may temporarily save some economic costs it exacts profound social costs. This, of course, is for the average person in our society, not the big hotshot investment banker who maybe used millions in public money but lost it all in the risky credit derivatives markets. He can usually expect to get bailed out in some way with the usual modus operandi: "private rewards- public costs".

Meanwhile, the "moral hazard" evoked by the Pareto optimality fetishists always ensures the public square, the common good and the little guys.....inevitably get screwed.

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