A Little Knowledge

Ezra Klein links to the video of lunatic CNBC business reporter Rick Santelli going on what appears to be an entirely sincere rant about the stimulus package and the Obama administration's plans to help distressed homeowners. As Ezra notes, "Santelli sells himself as a sort of financial sector Howard Beale: He's mad as hell, and he's not going to take it anymore. The problem is he's on the trading floor of a stock exchange surrounded by the very masters of the universe who started this mess."

At one point in the video, the conversation turns to idea of helping homeowners in danger of foreclosure refinance at lower rates. Santelli is having none of this, despite the fact that higher-than-projected mortgage default rates are what led to the rapid devaluation of allegedly investment-grade securities held by large financial institutions whose staggering blindness to such risk led to insolvency, frozen credit, a great recession (if we're lucky) and the end of the financial world as we know it. 

At that moment, the trading floor guy to Santelli's left turns and says "How about we all stop paying our mortgage? It's a moral hazard!"

The concept of "moral hazard" has itself become a hazard, I think. Like a lot of ideas rooted in economics, it's one of those insights into human behavior that isn't entirely obvious until somebody explains it to you, and then it seems like new window onto the world. Wikipedia defines it as "the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk." It's theoretically applicable to all kinds of situations: If drivers feel like airbags will protect them in a crash, they'll drive more recklessly, reducing the net injury-reducing benefits of airbags. If you forgive someone's debt, they'll borrow more recklessly, increasing the chance of future default. And so on. It's a useful perspective, something worth keeping in mind.

The problem is that "moral hazard" has for many people been elevated to the level of F=MA as an iron-clad law of the universe and as such is used to justify all kinds of cruel and spurious positions. It's aparently why we didn't bail out Lehman Brothers, which in retrospect looks like a catastrophically bad call. It's poorly understood by many as a catch-all justification for never offering any kind of helping hand. Empirically speaking, there's less evidence to support it than one might think--developing countries whose debt is forgiven don't actually have a horrible track record of subsequent reckless borrowing, for example. Air bags don't actually turn lots of safe drivers into reckless ones, because it still really sucks to crash your car. 

There's an educational lesson in all of this: picking up conceptual bits and pieces here and there without understanding the larger theory and complexities thereof can leave you worse off than if you'd never picked up the bits and pieces to begin with, because you think you understand more when you really understand less.