The classic case of moral hazard: (1) fires in Malibu burn down the
rich folks' homes. (2) the governor or even the President declares an
emergency and funds flow in to help; (3) rich people continue to build
in the Malibu hills while not paying sufficient attention to fire
safety.
Michael Perelman wrote:
> > Moral hazard came from the insurance industry. For example, because you
> > have
> > insurance, you may have less incentive to drive carefully.
raghu
> And insurance companies have ways of dealing with this by use of
> deductibles, increased premiums etc.
yes, but they don't always do a complete job. They can't always gauge
the risk completely.
> The issue is not so much that financial players have insurance against
> loss. The issue is that they are not paying for the insurance.
as with the Malibu example, they may not be paying _enough_ for the insurance.
> So I'd
> argue for a more generalized view of moral hazard to understand the
> way it applies in financial markets.
>
> e.g. Northern Rock did not have insurance to start with. They still
> (arguably) behaved irresponsibly and retroactively got the insurance
> for free.
because of the poor rating system for mortgage-backed securities, NR
may not have known what it was doing.
In the US, deposit insurance is mandatory for transactions accounts.
That's because _competition_ among banks encourages them all to
under-insure. It's not a matter of individual fecklessness.
> In other words, Northern Rock got to enjoy the benefits of
> an insurance policy without bothering to pay for it. And that is the
> essence of the moral hazard problem where someone gets a valuable
> consideration without paying for it.
but did they _expect_ to be bailed out? it's only when NR bases its
decisions of the presence of insurance that we see a MH problem.
--
Jim Devine / "The radios blare musak and newsak, diseases are cured every day /
the worst disease is to be unwanted, to be used up, and cast away." --
Peter Case ("Poor Old Tom").
