Tuesday, October 9, 2012

the last book I ever read (Twilight of the Elites, excerpt two)

from Twilight of the Elites: America After Meritocracy by Christopher Hayes:

A society in which cheaters, shirkers, and incompetents face no sanction, where bad behavior meets reward, is a morally hazardous one. In economics, the term "moral hazard" refers to the perverse incentives that can arise when agents are insulated from the cost of their actions: A hypochondriac with a health insurance plan that covers the full cost of doctor's visits will make more appointments than one who has a sizable co-pay; a banker who knows at some level that the cost of catastrophically bad bets will ultimately be picked up by the government has far less incentive to avoid blowing everything up while in the zealous pursuit of the highest yield possible.

One way to understand the financial crisis is as the natural result of moral hazard: major financial institutions only took the risks they did because at some institutional level they assumed that if things went terribly wrong the government wouldn't let them fail. Whether or not that was the case before the crisis, it's undeniable that the unprecedented actions undertaken by the federal government after the crisis demonstrated definitively that the government will step in to prevent the failure of institutions big and powerful enough to bring down the entire system.

If no one on Wall Street is held accountable for the crash, then what incentive is there not to grab another stack of chips and sit back down at the poker table? The same principle extends beyond Wall Street: an institution that rewards the reckless will act as a spawning ground for recklessness.

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