You’ve certainly read or heard the term, “moral hazard”. The phrase is often used in discussions about the consequences of the various bailouts offered by the Federal government in its efforts to strengthen the economy. It’s a term from the insurance industry related to how much one is enticed to avoid risk if the reward for the risk is greater than the loss associated with the risk.
If I have an accident that costs $10,000 and my insurance requires a deductible of 20%, I’m not likely to seek out the accident. If I have the accident, I’ll lose $2,000. However, if my insurance pays $15,000 because of the accident and I’ve only lost $10,000 – that $5,000 gain might entice me to experience the accident again.
Underwater homeowners have had assistance made available through various Federal initiatives. Some who wish to be bailed out are in their current situation because they borrowed against equity in homes that are no longer worth enough to support the loans. They owe more than the house they are buying is worth.
Here’s where the moral hazard lies: the “hazard” is the effect a bailout has one people who don’t receive it.
If my neighbor has a home mortgage “accident” that costs $500,000 and the government bails him out after he quits making payments, I may be enticed to not make my payments so I can receive that same benefit.
When a person who makes a bad choice is bailed out or made whole — like homeowners who bought more house than they can afford and have their loans reworked — the homeowners who have acted responsibly and receive nothing start asking, “Why am I being responsible?”
That’s the moral hazard you hear so much about lately.
