A cornerstone of free market philosophy is the concept of Moral Hazard.

From wikipedia – “Moral hazard is the fact that a party insulated from risk may behave differently from the way it would behave if it would be fully exposed to the risk.”

In other words, you’ll gamble more with other people’s money. Those most focused on moral hazard usually pair it with an individualism that can be summed up with the statement “people make their beds and should lie in them”.

As I’ve mentioned before, watching and researching the housing bubble has given me a concrete lesson in economics, and I’ve decided that in many but not all cases a free market solution will work, as long as you don’t mind the destabilization of society and/or the destruction of people’s lives along the way. It’s the wealthy, healthy, and white economist’s version of moral hazard: the underclasses take the personal risk.

There are other places where the free market doesn’t work, but that’s a different post.

However, moral hazard is also part of the building of bubbles. The repackaging of debt essentially offloaded the risk from those who extended subprime mortgages in the States, and through a basic con (a shell game, really), made making risky mortgages immensely profitable.

In Canada, this is still going on: CMHC insurance on non-standard housing loans essentially mean that taxpayers are absorbing the risk of iffy mortgages on behalf of banks. ( Here’s a bit from Garth Turner.) 

Banks/mortgage companies can make iffy loans because it doesn’t matter one way or the other. I’ve seen this – a loved one was offered more than she could afford because the loan officer decided they could “ignore” her other debt, for example. And simple online questionnaires show they’d offer my family a good deal more than we can afford, because of our credit rating, savings, and the current low interest rates.

The reason why, traditionally, no bank would have offered us much more than 3.5x income is simple – they wouldn’t want to take the risk of our bankrupcy if interest rates adjusted. It’s pretty clear interest rates have exactly one direction to go – up – and so it’s also pretty clear that giving us the most we can service at 3% is financial insanity on the lender’s behalf, because it’s likely we’ll default.

Unless the risk of our default doesn’t matter, cuz it’s offset by tax dollars.

To me, this sort of backstopping bank gambling is a bit wrenching, since when the bubble does let go, suddenly a tax base already paying for shit that matters – health care, the boomers aging, education, etc – will have to bail out the banks for making risky loans. No fucking way this makes sense to me, and I don’t know what to do about it besides writing strongly worded letters. But having the entire country go into debt because banks can’t lie in their beds once made makes a hell of a lot less sense than being a country that backstops the downward slide of the kid who made the wrong choice on a motorcycle, or the young family who was convinced by their own misunderstanding and the bank to take more money than they could service. If it’s really too much for them, they may not be able to keep their house: but they should keep their healthcare, and their kids should keep their schools. A bank lying in their own made bed makes way the hell more sense than an individual’s life being broken over a confluence of environment and bad decisions.

I’d say that unless inflation stays low for five years, we’re going to have a demographic and reset challenge in 2014. That’s if psychology and mathmatics doesn’t deflate this thing before then. At americacanada blog, however, a simple extension of the necessary credit expansion to make the market continue on the current trendline would put us at 283% of household income to mortgage debt in 2016, up from 45% in the 80s. Of course, we could have the mythical soft landing – inflation in wages, plus stagnant house prices, rather than a popping of the asset bubble – in order to take us back to a sustainable market. That wouldn’t put Ottawa on the hook.

Only I’m a pessimist on psychology changing enough to allow a soft landing re: stagnant prices. Since dipping 20% in 2008, Vancouver has pockets which have surpassed the previous prices. It’s stunning. And I don’t see any hope for wage inflation, unless they crank up those printing presses and devalue the dollar substantially. Which has many other problems associated. Also a different post.

Okay. So, that’s Moral Hazard, an example that makes government intervention really, really problematic to the efficient operation of the free market.

See how I have come to understand the financial Right Wing? Good socialist. Have a cookie.

Yesterday, however, I saw a really good example in me of an opposing force. No one talks about it on my economics blogs, although I’m sure that there’s a pretty good economic phrase to cover it. Shall we call it the “don’t buy the cow if the milk is free” law? Or maybe even “If milk comes from the tap, then people will get tired of it and go buy juice?”

Anyone who’s ever worked food service will know what I mean. I’ve worked at a bakery, and at a chocolatier, and at a coffee shop. And for the first month of any of those jobs, the take home of what you’re selling is hugely attractive. I drank so many vanilla lattes my first month at the coffee shop that I killed any urge to buy vanilla lattes since. I got sick of chocolate – ME! – working at the chocolatier’s. Very little interest in bread products after working at the bakery.

Any place that gave me free reign quickly made their product mundane, less desirable. Now, the rule was that I was only taking for my own use – I couldn’t offload to all my friends, or whatever. But still; meh.

John’s new job leaves the paying of BC Medical to us.

In Ontario, where we actually had universal healthcare, going to the doctor is something I avoided when possible, and went when I had to.

Getting the stupid BC Medical bill in the mail, though, my first thought?

“I’ll pay this, and then I’ll get of my duff to book appointments. I’m not paying for it if I’m not using it.” In my taxes, it’s hidden. Up in my face, I decide I’m going to use it because I’m paying for it. Only, really, all those months I’m not using it for me, I’m paying my own way for the future, or helping the guy with cancer down the street. But the act of paying specifically draws my attention, specifically.

It’s like being on a diet. When you’re hungry enough, being denied a piece of cheap slab birthday cake seems an insult to hard to bear. If you’re nourished, you’re free to say meh. Slab cake.

I remember being in the States and talking about recovering from a kidney infection; my doctor aunt talked about all the things she figured I needed to have done to check on me. My doctor aunt works in American health care but won’t work with HMOs, and she was suggesting stuff I didn’t really need for my health; but if I were *paying* her what her patients pay her, then I’d want that attention, wouldn’t I? Sure I would.

Now, there are some things where use or risk needs to be part of the equation. For example, paying for our gas and electricity does encourage us to conserve. And there are other things – like removing some of the personal health or educational risk from the underclass so that they can be more entrepreneurial, or part of a more fluid work force – where giving the risk to society also provides benefit to society.

But sometimes, letting people have their fill makes them less likely to want. Other than paying for it so you might as well use it, or suffering Munchausen’s, who really wants to spend that much time in a paper gown?