Learning to Live with Moral Hazard

Yes, some undeserving will be rewarded, but we can get over that

Summary (in case you don’t want to read the whole thing)

People wanted (and to some extent needed) more things but weren’t making enough money to pay for it; so they made up the difference by borrowing. Many people went too far and ended up bankrupt or at least in serious trouble, affecting the broader economy. The very nature of the capitalist system encouraged them to do so, though. It’s unreasonable to hold it against them when making policy. People aren’t helpless and shouldn’t be entirely absolved, but neither should they be held totally responsible.

Background

At first, people were lucky if they could make just enough goods to stay alive. As they got better at making goods, they became able to produce more than they needed. Then the financial crisis happened.

Okay, actually a lot of stuff happened in between the genesis of economic surplus and the bursting of the debt bubble. But the former thing led pretty much inevitably to the latter.

Producing more than they needed, people began to trade their extra goods for other people’s goods. People realized that it would be more efficient to have one easily-portable thing that could be used to buy anything; i.e., money. Since this new thing could buy anything, it soon became more valuable than actual goods, which in order to trade had to be of some value to a potential buyer. But a buyer didn’t need a special reason to value money, since he could in turn spend the money on whatever. So people went from learning how to make more goods than they needed, to learning how to make more money than they needed. Hence interest, stocks, bonds, and now derivatives and hedge funds. Making money for the purpose of making more money.

Eventually the economy came to be based more on making money than making things that were useful in themselves. But useful things were still produced, and quite abundantly, as the money-makers invested in technologies that made more goods with less time and work, so that people had the time and resources to focus on making more money. But this created a problem as a great disparity opened up between people who had money to invest and those who made just enough to pay for basic needs. The more money wealthy investors had, the easier it was to make more, and accumulate greater wealth (and power over the economy and politics).

This was not the birth of social inequality, of course, which had existed since people began settling down instead of constantly moving around in search of food. But now there was no longer any natural limit on the degree of inequality that could be generated, as more money could always be made, and used as leverage against people with no extra money, to prevent them from being able to negotiate for better pay for the work they did. Some people controlled so much wealth that they didn’t have to negotiate with regular folk at all, as they could easily find someone willing (that is, desperate) to work for them for whatever paltry wage he had no choice but to accept in order to pay the wealthy for the privilege of living on their land. Regular folk very belatedly acquired the right to vote in order to have some say over their governance, but you had to have money to have any real influence, so government ended up being largely a servant for the wealthy. People could really only select a leader from a list decided upon by the wealthy elites. So government became a driver of greater inequality rather than a check on it, a reality only partially mitigated by progressive reforms such as fair labor practices laws and collective bargaining rights, which by making the economic situation more tolerable for the masses, actually secured the capitalist system by protecting it from popular revolt. The concentration of wealth continued to increase, but so did the living standards of even the poorest people, so the system kind of worked for everybody. 

Back to the Present

Thus a highly productive capitalist economy (generating surplus, if also much waste) has meant living standards have risen, even for the poor. But wages, for a quarter-century, have been basically flat, for the vast majority of workers. The last twenty five years of the 20^th century saw the success of an aggressive political movement to roll back many of the progressive policies that gave ordinary people security and bargaining power. Secure full-time union employment has given way to temporary part-time jobs with no benefits or collective bargaining rights. Wealth has become more heavily concentrated among the richest people than since just before the Great Depression.

But the culture has made it harder to settle for just good enough. The American Dream is essentially to be middle class. The material standards that qualify a person to be middle class have increased: two cars rather than one; a large house rather than a small one; a college degree, not just a high-school diploma. Each qualification means more expense. But individuals aren’t making much more money than people in similar positions were 30 years ago, allowing for inflation. Families partly made up the gap by married women working. But largely the increase in living standards has depended on massive borrowing. Which might have seemed fine until recently, though in retrospect such thinking seems positively foolish.

Who’s to Blame and What to Do About It

It is easy to say (as many conservatives tend to) that people didn’t have to buy all those fancy things. They could have lived more modestly, saving extra cash for their future, as past – presumably more sober-minded and responsible – generations did. Settled for smaller houses, fewer toys for the kids (and adults) and such. Which is literally true, if still an unsatisfactory response to the related problems of growing financial insecurity and economic inequality. The problem with their argument is only that it stops there. It’s a valid point, but it also ignores a lot of important facts. There is a tendency to assume that individual virtue alone can protect people from bad economic outcomes, and discount or minimize larger economic and social forces that influence people’s actions.

People surely had better save their money and not borrow what they are unlikely to be able to pay back, but just as surely, people (most, anyway) will spend and borrow to the limits of their ability (i.e. how much a bank will lend them) and get themselves into the kind of trouble that threatens the whole economy, not just their own personal finances. In doing so, people are not being wise or fully responsible. But it’s asking too much to say they ought to be. Even well-meaning people will necessarily make bad decisions and get themselves into trouble. The disagreement is over the question of what to do when this happens and affects the broader economy.

There is not a neat line dividing responsible borrowing from the dangerous kind. There is a spectrum. Along that spectrum lay choices between competing values: we want to save for the future, but we also want a house with enough room in case Mom has to move in with us; we want to save for our retirement, but paying more for a premium college education for little Johnny could pay off in the long-run. And so on and so forth.

To be sure, some people – at the bad end of the spectrum – make pretty obviously irresponsible choices. It seems unfair that others should be required to bail them out when they do. But my claim is that most people are not on that end of the spectrum. Most are somewhere in the middle between saving as much as possible and spending as much as you can borrow. The critical point is that people sit along all points of that spectrum and any policy we make regarding sound economic decision making and problem-solving is inevitably going to be justly accused either of punishing the innocent or of absolving the guilty – because of the absence of that neat line between the two. It’s too difficult to separate everyone. If we decide, for example, to bar foreclosures, we are surely letting some irresponsible people; but we’re also helping deserving people who just had really bad luck. For some, punishing the guilty appears to be more important than protecting the innocent. For others, it’s the other way around. Either way we will necessarily fail to mete out perfect justice.

The point? Let’s quit worrying about the moral hazards of bailouts and focus on promoting general prosperity. Else we’ll face problems more serious than the unwelcome side effects of letting people off the hook.