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John Fishback on Moral Hazard, Cottonwood Coffee, and Debate Coaches

Did someone say "moral hazard"? Time for some brain TV!

"Tie-wearing management consultant" (his description) and really smart Brookings dude (mine) John Fishback presented the following talk at the first TEDx Brookings event in February. He talks about the term "moral hazard," its academic pedigree, its use in current discourse on public policy, and its relevance in the context of his hometown:

Among his key points, Fishback says we should not place theoretical incentives to recklessness above empirical evidence of practical benefits:

If the mere presence of moral hazard was actually an argument against action, no insurance policy could ever be written or sold, ever, and no government policy at all could ever be put into effect. So those who forcibly conscript economic thought into the service of their argument by using the thin gruel of "what economists call moral hazard" rather than doing the difficult work of economic analysis claim a level of support for their position that just doesn't exist. They are suggesting to decision-makers that the public is protected from the risk of a bad decisions because experts have evaluated possible outcomes, even though experts have not [John Fishback, "What Economists Call Moral Hazard," TEDx Brookings, 2014.02.21].

Fishback notes that the academic debate over moral hazard seems to have shifted responsibility for "bad" decisions from individuals to the situations and incentives created in the marketplace. Fishback turns to his hometown, to his neighbor Jacob Limmer, his mom, and his old debate coach Judy Kroll, and says (I perhaps oversimplify) nuts to that.

People choose to... create the communities they want at the expense of their own economic incentives all the time [Fishback, 2014.02.21].

Fishback says Limmer could have saved himself a lot of money and effort opening a Starbucks instead of Cottonwood Coffee. But Limmer chose to go his own way. The result:

When you go into Cottonwood Coffee, you know you're in Brookings, South Dakota [Fishback, 2014.02.21].

Fishback says his mom bought a plot of land in town with a house valued at zero and refurbished the house into a lovely little rental with character. Fishback says Judy Kroll passed up lots of more lucrative coaching opportunities to teach him and hundreds of other Brookings kids how to make a speech.

She taught me how to make a speech. And I don't know if her doing so made her community into what she wanted it to be. But her doing so has helped me make my life into what I want it to be [Fishback, 2014.02.21].

Fishback says his Brookings neighbors show the hazards in conventional moral-hazard theorizing. He does not reject the idea that economic incentives can incent. He simply rebuffs those who would assert moral hazard in theory without examining the real effects of real policies in real communities like Brookings, where people are not pinballs:

No matter what Mark Pauly says about the economics of a situation driving our choices, it is us and not our incentives that make our choices. If we want to live in a healthy rural community, then we need to make choices about how we want things to be rather than seeing ourselves as at the mercy of larger forces. We are not a product of the forces acting on us. Our community is, not nothing more than, but as much as the sum of all of our choices for it [Fishback, 2014.02.21].

Heavy thinking like Fishback's makes me want to see another TEDx Brookings really soon!


  1. Douglas Wiken 2014.05.31

    I never quite got the meaning of "moral hazard" when it was discussed in terms of the bond house bankruptcies and economic crash and I must confess whatever Fishback you quoted here hasn't really made it a bit clearer.

  2. Chris S. 2014.05.31

    The way I've seen "moral hazard" used in context — whether it's an official term sanctioned by Mr. Fishback or not — is to imply that there are consequences to be suffered for "reckless" behavior. That's the common usage, anyway. It's used by writers such as Charlie Pierce and Paul Krugman when discussing economic issues to refer to the attitude of our ruling classes that the "little people" should suffer for "bad decisions" that they made — for example, when they took out a home loan. (Never mind that they may not have fully understood the terms, and in any event there are two parties involved in any loan, not just the borrower, and presumably both would be at fault.)

    Of course, the term is loaded with irony because "moral hazard" never applies to Wall Street when they cheat, steal, and crash the economy. "Moral hazard" is only for us little people. I suppose it's for our own good, to purify our fiscal souls. [/snark]

  3. WestRiver 2014.05.31

    I think I'm in love...ok ok maybe not love but I do appreciate a great mind...a lot. Thanks for sharing Cory; this is a great message to those who know they want to do something, anything and don't know where to begin.

  4. Deb Geelsdottir 2014.05.31

    It may have been snark you employed Chris S, but it was honest snark. Must be correct too, because I was thinking about how "moral hazard" seems to be a concern only for the little people too.

    Grrrrr with a curled lip.

  5. larry kurtz 2014.05.31

    How do the Hills look, Stan?

  6. Lanny V Stricherz 2014.05.31

    Damn, Larry, A couple of days ago, you asked Blindman how the creek looks and he wrote a poetic prose style treatise on how beautiful it and the Badlands look with all the rain you guys have had Westriver. Now you ask Stan how the Hills look. And here I sit without a car. Thanks a lot for trying to end my attempts at being green.

  7. larry kurtz 2014.05.31

    Imagine a magic carpet made of steel between Sioux Falls and Rapid City, Lanny and help me save a state i once loved.

  8. Stan Gibilisco 2014.05.31

    Larry, these hills be green.

    Went down to Spearfish today ... Green as Ireland.

  9. Stan Gibilisco 2014.05.31

    High speed rail? Here? In South Dakota? A moral hazard just to dream it.

  10. larry kurtz 2014.06.01

    Sioux Falls to Rapid City then to Cheyenne, Stan. Amtrak is almost ready to pull the trigger on a Cheyenne to ABQ plan.

  11. larry kurtz 2014.06.01

    Hey, Stan: interested in helping me buy Ardmore?

  12. Les 2014.06.01

    Give up on saint onge, Lar?

  13. larry kurtz 2014.06.01

    christians give me gas, les.

  14. Les 2014.06.01

    Me to, Lar. They sure can cook!

  15. David Bergan 2014.06.02

    I got this one.

    Moral hazard is usually an insurance term. In insurance, the terms RISK, HAZARD, and PERIL are three separate entities.

    PERIL is the loss that is suffered.
    HAZARD is the thing that gives rise to the PERIL.
    RISK is a situation that may have a HAZARD.

    e.g. Your car is wrecked, that is the peril... and you file a claim to your insurance company (assuming comprehensive car insurance). The icy patch on the highway that caused you to crash your car is the hazard. The act of driving your car is risky (no chance of wrecking it when it stays in the garage)... and the highway was particularly risky because it was full of hazards.

    So, again, hazard gives rise to peril. Then insurance companies distinguish between three kinds of hazards: PHYSICAL HAZARD, MORAL HAZARD, and MORALE HAZARD

    The icy highway is a physical hazard... something physical that causes peril. Getting sick from tainted food would be another example.

    A moral hazard is when an insured's habits or values give rise to a peril (e.g. the habit of smoking gives someone lung cancer, or the habit of not using a seatbelt causes them to be paralyzed).

    A morale hazard is similar to moral, but relates to temporary heat-of-the-moment type situations... like if you wreck your car because you were driving quickly to take your son to the ER. It's not your HABIT to drive recklessly like that... something caused you to act outside of your normal behavior. Also, crashing a forklift because you didn't get enough sleep the night before i think would be classified as morale hazard.

    Now the tricky part of insurance is that the act of purchasing insurance can change a person's habits/morals/values... a depressed person may more likely commit suicide once they have a million-dollar life insurance policy for the family. A shopowner may blow off an inspector's report if they have insurance to cover their business. A website owner may take fewer anti-hacking measures, if they have insurance to recover loss of revenue due to a security breach.

    It's this kind of insurance-induced-moral-hazard that Fishback was addressing... except that it's more the implicit insurances in our society rather than the explicit ones. Explicit insurance usually has legalese in their contracts to hedge insurance-induced-moral-hazard like how a life insurance policy won't pay for suicide in the first 2-3 years of the policy, and workman's comp won't cover injuries on employees using company tools for non-job-related projects. Self-inflicted injuries typically aren't covered by an accident and sickness policy.

    Implicit insurance are the things where the government steps in to help just because, you know, we have a great civilization and can afford to do that. The crux of the issue is right here: (a) everyone should reap what they sow or (b) we should help people who suffer misfortune. The other half of the issue is whether the government should be involved in (b).

    I think anyone who argues for either (a) or (b) exclusively is misguided. It really comes down to the specifics. As for government involvement, well, there are some problems that are simply too large for anyone else to solve. No other entity COULD possibly have saved the banks in 2008.

    SHOULD they have saved the banks? That's a great question... and one that we can attempt to investigate in hindsight... but staring down the barrel of total economic collapse, with one weekend to make a decision, the case of letting the banks reap what they sowed was practically impossible.

    As a country, we passed over 100 pieces of legislation from 1803 to the 1930s as ad hoc responses to crises. Then Herbert Hoover (R) established a part of the government to respond to such emergencies. He was a first class crisis-helper guy... making his pre-President reputation on solving famine in Belgium and attending to the worst flood in US history (1927 Mississippi River flood). But his crisis-solving skills fell short on The Great Depression. Herbert was willing to start government job creation programs (most of which were delayed by Congress until he was out of office so FDR could get the credit), but could not philosophically entertain the idea of creating government entitlement programs. His ideals are very close to those we hear on today's conservative talk radio, and he was very strict in keeping to said principles... not a hypocritical man at all. He thought that the people who invested in the stock market deserved to live with the crash of '29 because losing is a part of that game. The government subsidize poor investments? The government bailout the companies? Ain't that moral hazard??

    The lesson he learned the hard way was that when a modern economy takes a hit like that, there's significant collateral damage. He was willing to use the US Government to bailout people who had been devastated by Mother Nature, but it felt wrong to bailout out citizens who are devastated by a catastrophe of our own making. And, to be fair, economics was still in the stone age, relatively speaking...

    So back to moral hazard: There's always tradeoff between moral hazard and government entitlements/implicit insurance. If we have universal health care, that removes (some of) the incentive to be responsible for one's health. No matter how I screw up my body, the government-run hospital will bring me back to healthy... so bring on the carcinogens and STDs. If there's an implicit promise that the government will restore my house after a flood or wildfire, then I can freely build a house in areas that might otherwise strike me as too-risky. If the government is going to reimburse my farm for failures in a drought, why bust a hump to maximize my yield in a dry year?

    Personally, I think these are good programs, and that our country is prosperous enough that we can shoulder a little moral hazard. But, just like the subprime mortgages, if you take on too much of it, it will sink the boat... and many responsible people sink with it.

    Kind regards,

  16. Douglas Wiken 2014.06.02

    Thanks for that discourse, David.

    Incidentally, what is it called when somebody like Rounds builds a house inches above the water level and then blames a government agency for the flood?

    Similarly, I have watched a few This Old House episodes on SDPB-TV where houses are being rebuilt on slender piles of sand off the Jersey Coast. Much of that is being done with government and insurance funding apparently. My name for that would be rewarding short-sighted stupidity and ignorance.

  17. David Bergan 2014.06.02

    Right. Before Hoover, a home builder would be less likely to take on risk like that.

    The devil is in the details. In explicit insurance, the company evaluates the risk and either rejects it or prices it accordingly.

    In implicit government "insurance" we want the government to help citizens who suffer com the whims of Mother Nature, but there is no evaluation process ahead of time where the government can reject certain risks. It's kinda all or nothing... which creates a system that can be gamed... just like all entitlement programs.

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