Moral Hazard

“Moral hazard” is a term used in the insurance industry to refer to the way in which behaviour alters when people acquire insurance. People with house contents insurance are less careful about locking up. Such behaviour in the eyes of insurers is “immoral”. The term stigmatizes human nature. We all adjust our behaviour in response to our perception of hazard – we all slow down when we come to a sharp bend in the road.

The term is now enjoying unprecedented popular exposure in discussions of the Bank of England’s rescue of banks and building societies. Might rescuing them from the consequences of foolish decisions encourage more foolishness? A good question but not sufficiently sharply focussed.

It is not the banks, and all their clerks, depositors and shareholders, who have been foolish. It is particular individuals, whose culpability is strongly correlated with the size of their salaries and bonuses during the boom years. Their behaviour merits the label immoral because they have been reaping their enormous, risk-free rewards in a system rigged in their favour.

The economy has come to a sharp bend in the road. Those responsible are still in their hummers, with bull bars, air bags and seat belts. Why should they care? Why should they behave differently in the future? Unless the rescue operation confronts the incentives to immorality built into the current system, they are unlikely to slow down.

Published in abbreviated form in The Guardian 24 April 2008

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