business, insurance, money

Moral Hazard and Common Decency: Response to the film Inside Job

In 13 Bankers (2010), Simon Johnson defines moral hazard as “the temptation for bank executives (and shareholders) to take risky gambles, knowing that they would benefit from success but that taxpayers would bear the losses in cases of failure” (p. 177). With moral hazard self-interest may overcome responsibility for caution to avoid calamity. In any business endeavor in which  a) risk is pursued, b) gratification is experienced in huge amounts of wealth, and c) regard for those exploited is systematically ignored or denied, morality has defaulted or ceased to exist. Instead of “the greater good” the result satisfies only “the lesser good”—those in a small percentage who benefit.

Is it possible for experienced bank CEO’s, academic advisors with advanced degrees from prestigious universities, and presidents to pursue hazardous economic programs with little concern for the moral delinquency in their actions? The US 08 financial meltdown indicates self-interest and greed overcame common decency at the highest levels of US economic governance.

Analogies are tempting although usually oversimplified, no matter how colorful. But here’s one that may have some application. The Titanic is sailing toward the iceberg. As it proceeds rapidly on course, the pride of the modern ship building and cruise ship industries, warnings are given to change course. It does not change course and comes the moment of impact; the
ship goes down in a catastrophe of property destruction and lives lost. But the captain and company executives who charted the course are not held responsible. These gentlemen represent what is “too big to fail.” The industry is replenished with funds to keep it going via taxpayer money in a humongous bailout. Another Titanic is launched on the same course toward the iceberg with the same crew. Far from being investigated and held responsible, they are rewarded with large bonuses and restored to the helm.

Against an understandable critique of irresponsible leadership—Wall Street, academia, government—the response has been ideologically defensive. This position holds that moral hazard involves risk, and it’s not helpful to lay blame after the events bringing the crash.
This same defensive posture maintains that, in principle, making money, large amounts of money including enormous bonuses (as with, say, a 100 million dollar bonus in one year) is the nature of marketing and the American way. We are a capitalist system, not interested in the heavy hand of government regulation and control. Within this view has come a naïve assessment of human nature as essentially benign. We all mean no harm, and essentially we regulate ourselves; therefore, there is no moral hazard really. Indeed, with this viewpoint common decency is the fundamental life-blood of the system. 

This argument somewhat runs into difficulties with conflicts of interest—again inviting consideration of moral hazard. Suppose a used car dealer shines up his stock of autos and they look very good. Additionally, they are stamped with high ratings, in many cases as triple A from associated used car-rating agencies. However, as all sales personnel at the dealership know well, the cars won’t run longer than a few months before collapsing. Sales
personnel refer to them as “crap.” Additionally, the dealership decides to insure on sales of these cars—betting they will become junk in a short time. The vehicles are sold with smiles and handshakes; happy customers roll forth from the used car lot. Sales personnel are awarded large bonuses. Hoodwinked customers are less pleased and some bring lawsuits, hardly noticeable amidst the boom in sales and credit default swaps.

Still, however, the ideologues for a non-regulated economic system—because government is inextricably wicked and “the problem,” as Ronald Reagan liked to say—will contend that the system is ideologically sound. That is, the Reagan ideology posits the essential good of unregulated markets working creatively to benefit and uplift an entire society, not just the
financial sector. Government regulation hinders freedom and creativity—the American way. The 08 crisis and the ones before that dating back through the Depression and to the 19th century were anomalies, or momentary setbacks in a thoroughly sound scheme. After all, look at the rapid recovery of the financial sector from 08. Isn’t this the essential proof that the 08 crisis was anomaly? The government played an essential but minor role in engineering a
bailout leading to a re-distribution of the power but leaving the system intact.

This argument continues that true, some lawsuits have been brought against the most egregious cases of moral dereliction. Deservedly. Nevertheless, overall the marketing system remains intact and at status quo. Marketing involves the selling of products and insurance for those products. Those who buy products must assume responsibility for the quality of those
products. If someone had acquired a mortgage at 99.3% of the value of the property, that individual certainly knew of the risks involved. Moral hazard surely applies to customers as well as sales personnel. It is senseless—this defense continues—to lay blame on only one side unless there was fraud, which we are not aware of. As to conditions in fine print, the customer is beholden to understand, and responsible for failure to understand. Ultimately, this
defense concludes, the unregulated system is correct, even in the face of occasional deviance. There is nothing wrong with being rich.

These arguments sound very fine and are accompanied with grim faces and quizzical brows during investigation with congressional committees. Contradictions and conflicts of interest are frowned away. When bets are hedged from selling “crap” by insuring with AIG on its being indeed crap there is no conflict here in marketing, as indicated by Lloyd Blankfein,
CEO of Goldman Sachs. That is, I hazard that you buy my crap fully aware it is crap and will do with it as you see fit, and surely in a manner suitable to cash-generation in the system. I don’t need to disclose that it’s crap nor warn that its AAA rating is merely an “opinion” from a rating agency which means nothing and isn’t reliable. You understand that. In this my hazard with this particular business venture you are complicit in product magnification to huge
cash reward. There is no “moral” factor whatever. The “moral” in “moral hazard” has become irrelevant. Within partnered ideologues in this system it should work. If I buy your crap knowing it’s crap intending to sell it and insure it with AIG myself whether it’s crap or not makes little difference.

But here is where the brain’s executive functions in these brilliant minds in the consortium—bank CEO’s, academic advisors, and government representatives—are subject to waffling, denial, and even complete breakdown. Answers to questions are laced with stammering and prolonged silences. As some point gratification in terms of huge payoffs, whether bonuses, fees, or political donations, leads to non-thinking and obsession with the pleasure
zones, and fall-back to exhausted rationales developed over the past thirty years.

Even more important in the breakdown of executive brain functions is the shutdown of compassion guided by empathy. The assumption that we’re all smart guys who know how to manipulate the system—my triple A rated crap insured with AIG is fully understood by you when you acquire it and follow suit—does not spread far enough to the general unsophisticated public who don’t recognize crap or understand the fine print. Barracudas may swim together with no harm, but at least their prey possess instincts and suspicion.

Six million previous home owners in the US on the way to nine million more this year were too easily misled in the dreams nourished and facilitated by an industry building the bubble and crash of 08. Whether borrowers had sufficient prospects to support their loans, whether they understood an escalating payment system, whether they were aware of declining
manufacturing, whether they needed the common decency of expert guidance,whether they were going to default toward the hazard of an enormous eocnomic crisis—none of this mattered to a system delighted with itself, its money, and its rationalizations.

The eyes glazed, the brains triggered pleasure stimuli, the ability to empathize vanished, and memory provided “A sucker is born every minute.” The lesson turned backwards on Ronald Reagan: it wasn’t government that was the problem. It was the entire power structure adrift in hedonism and greed. We need investigation, a special prosecutor, and action on this crisis.