Katrina Compensation--Posner's Response to Comments

The first comment I would like to respond to is Professor Becker's. It flags an issue that I did not discuss adequately in my posting. He argues that the fact that an individual loses property or for that matter life in conjunction with similar losses of other individuals in an event reasonably classified as a disaster or catastrophe is no reason to stretch the social safety net beyond its usual dimensions; the individual should be treated identically to a person who sustained the identical loss in a noncatastrophic setting--say as a result of a pipe's bursting while the owner of the house was away for several weeks and when he returned the house was so flooded as to be completely ruined. I think Becker is basically right, and indeed I made a similar point in my posting but then wandered away from it. But I also think that there are some differences between the disaster and nondisaster settings. In my hypothetical bursting-pipe case, there would be no occasion to evacuate the owner to another city. As in this illustration, the disaster setting is likely to involve costs that would not be incurred in the nondisaster case, and the social safety net may not have been designed with that possibility in mind. Of course it would be better to alter the net to take account of the possibility, rather than, as we are doing in the aftermath of Katrina, responding ad hoc, excessively, and probably wastefully. My posting distinguished between insurance against loss and damages for a wrongful act; damages are more generous, including for example monetary compensation for pain and suffering. Several comments question the distinction. Let me offer two responses. First, if there was culpable negligence in the handling of the catastrophe by officials or public employees, it is conceivable--no stronger word is possible--that victims of the hurricane and of the ensuing flood may have a legal claim. I say "conceivable" rather than "possible" because there are a number of limitations on suits against public officials, especially suits based on their discretionary acts or their policies, as distinct from execution (usually by lower-level officers such as policemen). Second, the demand for insurance and the (social) demand for legal liability are quite different. The demand for insurance is based on risk aversion, which is based in turn on the declining marginal utility of money. Ask yourself whether you would pay $10 to avoid a one in ten thousand chance of having to pay $100,000. These are actuarial equivalents ($10 = $100,000 x .0001). So if you would prefer the riskless alternative (pay $10), you're risk averse and a potential customer for insurance. So if, as in the usual case, pain and suffering would not reduce your money income, there would be no point in your buying insurance. But since pain and suffering are a real loss, optimal deterrence of acts that cause such a loss require the courts to try to put a price tag on the loss and include it in damages. I was intrigued by the suggestion in several comments to make the purchase of flood insurance mandatory in areas where the risk of flooding is significant. It sounds like a good idea, provided those areas can be defined (the alternative of making flood insurance mandatory for everyone, even in deserts where the premium presumably would be close to zero, is objectionable as being administratively cumbersome) and that the insurance is not subsidized by the government. If it is not subsidized and therefore represents the insurance industry's best estimate of the expected financial losses from flooding, then requiring it will discourage construction in flood-prone areas (by making it more costly to live in such areas) and by doing so will reduce losses from floods and reduce demands for government bailouts--demands that appear to be leading to extravagant federal programs for compensating victims of Katrina. Compulsory insurance is a second-best solution from an economic standpoint; first best would be letting people choose whether to insure or "go bare" but not compensate them if they chose not to insure and then suffered a big loss. But it is unrealistic to expect government to take such a hard line in the disaster setting, where the number of victims is so large as to place the government under irresistible pressure to compensate--unless the victims are privately compensated through insurance.

Comments

[Palooka]

"I think Becker is basically right, and indeed I made a similar point in my posting but then wandered away from it. But I also think that there are some differences between the disaster and nondisaster settings. In my hypothetical bursting-pipe case, there would be no occasion to evacuate the owner to another city."

I made a similar point in my post on Becker's comment. Some additional help is appropriate, such as bending some of the rules for unemployment, medicaid, etc. But this still does not justify the zero compensation for those who incur personal tragedies and the near full compensation you seem to propose for those who are poor and were without insurance. Their situations are NOT that different, Judge Posner.

I agree fully that government can and should play a role in getting the victims of Katrina on their feet again. This includes assistance, financial and otherwise, of relocating, finding suitable employment, enrolling their children in schools, etc. I think most of that is uncontroversial. Compensating the uninsured for, perhaps, fairly significant losses goes beyond getting people on their feet again, and instead seeks to place people people in a position equal to (or perhaps better than) where they were before Katrina. That is, as I see it, an unconscionable abuse of taxpayer's money, and a dangerous precedent for the future of insurance generally.

I have no idea why you think the government is under such intense pressure to compensate the uninsured for their property losses. Yes, Americans want the government to help those who lost homes and jobs because of Katrina. That does not equate, however, to "irrestible pressure" to financially compenstate the uninsured. The distinction, as I see it, is the difference between getting people back on their feet versus putting people on parity with their pre-Katrina situation.

[David]

If private companies will not offer the flood insurance that Posner agrees should be mandatory -- and they might not, since they often will not insure against disasters -- it should be provided by the federal gov't. The best statistical assessment of risk should be used to calculate the premiums. That way, hopefully, a good portion of the politically-mandated relief that follows disasters will have been paid for in advance.

[Bob Phelps]

Consider a world in which there is a government provided "safety-net". In that world, a government declaration of "disaster" is a statement that the government views circumstances in an affected area as warranting a provision of "safety-net" benefits as either differing in quality (i.e. in that world, the government doesn't ordinarily provide it's citizen's shelter on an immediately available basis unless they can show by some formal mechanism that they have assets and income below a certain level), or different in quantity (more people who are entitled to a safety net benefit make use of that benefit than is the norm.)

Either way, in that world, the government's declaration of disaster is entirely a declaration of the state of government, and in that ideal government, there are anticipatory mechanisms that allow for resource allocation shifts and even long-term compensation to those who finance such shifts.

In this ideal world, the private sector continues along doing whatever it does, however efficiently or inefficiently, and, in that ideal world, only contract provisions regarding disaster apply.

[Wes]

Since every aspect of mandatory flood insurance would have to be specified by government regulations, it is not clear to me that private flood insurance would be any more efficient than a federal "flood tax" on homes that were likely to be destroyed by catastrophic flooding (and subsequently rebuilt by the federal government).Ordinarily, an insurance company has to balance its books each year because the payouts for the year need to be more or less balanced by premiums payed in for the year. For catastrophic flood insurance an insurance company might go for 50 years without making a single payout and then have to make payouts to all its customers in a single year.An insurance company that offered a certificate of "complete coverage" to satisfy a government insurance requirement for a very low price of $1 per year would be quite successful (for the 50 years until the flood happened) because no one would really care if the company had the cash reserves to cover the payouts in event of a catastrophic flood - they would only care about satisfying the government regulations. If the company went bankrupt 50 years down the road when the catastrophic flood happened then no one would really care. Personally, I wouldn't really care if the government chose to forgo a flood tax or mandatory insurance on the grounds that it would be costly to administer. What does seem bizarre, however, is the Bush administration's plan to offer tax breaks as an incentive for companies to stay in New Orleans. That seems spectacularly inefficient from an economic perspective.

[Andrea Santos]

Hello! I¥m making research on Weblogs and I need to find the profile of a professional weblogger. I was wondering if I could interview you, Mr. Becker and Mr. Posner? It is a short interview about your activity as owners of a weblog.
Thank you!

[N.E.Hatfield]

Mandatory flood insurance? I thought it was already in place. At least as far as federally secured property loans in severe flood prone areas was concerned. See 12CFR, Sec. 300 to about 390 (I think, some place in there at least). As for locations, the analysis has been done years ago and is continually revised annually to take into account urban growth and development and is called the "FIRM" map; maintained by FEMA and available to all Lenders and private citizens.

If there is a problem, it lies with the Lender and private citizen, not the Fed. Perhaps it's the same old story, the laws exist on the books, but are poorly enforced. Before we implement a new program may I suggest we enforce the law as it already exists.

[David Willliams]

The poor will be with us always, I can't understand the great amount of discussion that deals with this issue. We have poor people; they don't make sufficient income to support themselves either from lack of ability or from lack of gumption. Either way they are poor. Unless we decide to let them starve to death it is up to us to provide them with at least minimal sustenance. It shouldn't surprise anyone that poor people lived in the metro NO area. I know of no metro area where there aren't pockets of the poor. And it shouldn't surprise anyone that these poor people lived on the low ground; the ones with sufficient monies moved from there long ago. I don't have any knowledge on the subject but I doubt that any great majority of the NO poor who lived in the low lying areas owned their own homes. More likely they rented and rented with subsidies. A modest proposal when rebuilding NO is to prevent subsidized housing from being rebuilt in flood prone areas. Given that there is a paucity of non flood prone acreage, this presupposes that certain of the poor will be prevented from living in the rebuilt NO. My guess is that the more affluent NO residents who depend on the poor to rear their children; mow their grass; pick up the discarded pop bottles and aluminum cans; and provide the street entertainment which makes NO NO; would miss the poor. This of course is not limited to NO noblesse. So we can anticipate that the post reconstruction NO poor will be right back where they started from, looking up at the river. We can rail about the cost of rebuilding NO, but rebuilt it will be and with federal tax monies for the most part. NO is a necessary port and the NO area is a necessary energy producer and refiner. Ports, refineries, oil wells, require a lot of worker bees and support facilities. So a town or city will grow where they are whether we call it NO or New Amsterdam. Quit railing about the cost, the US can afford it. Get on with the task. More important is whether we will ever do anything about the poor other than to throw enough ducats at them to prevent insurrection. uprising. I doubt we ever will. As Judge Posner states Denny Hastert had to eat crow for telling the truth as he saw it; no other politician will ever do anything but throw money at the poor. There is no end to this epistle so I sign off.

[Frank]

Regarding full income and longevity isn't there an assumption that "productive longevity" increases proportionally with "physical longevity?" Otherwise the full income growth would not be sustainable, e.g., if the longer lives were spent more in nursing homes.

[Daniel Covel]

Rather then make flood insurance mandatory, I offer a slight alternative. I would have federal incentives for communities to charge a local flood tax (or a natural disaster tax). For example, Gulfport would charge all residents a flood tax, part of the tax would be used to buy private insurance for the community and part could be used to take preventative measures (flood wall, shelters, etc).

Your premium, or tax, would be based on how close you are to the shore, are you in a flood plain, quality of construction etc. If you are in snow or tornado country, the tax may be more evenly charged.

The federal government could then sell discounted catastrophic insurance to these communities. Communities would be self insured for most "basic" disasters, but the federal government would offer something like replacement value for properties in the affected community with fewer restrictions on types of damage etc.

The downside is that wealthier communities may be more inclined to self tax. After a disaster politicians may find it hard to give preferential treatment to some communities, especially wealthier communities, even if they had payed into some superfund.

A city like New Orleans may decide that they have enough political clout that they don't need to buy insurance. In the event of a disaster, they will use political muscle and the media to buy them federal funds.

As an alternative, the federal government could help the self insured in the building of flood (or other natural disaster) prevention measures. Evacuation routes, shelters, flood walls, emergency response equipment and other local projects. But as we have seen in New Orleans, money targeted for flood protection sometimes gets lost in translation.

Given the politics we have, the current system will stay in place. The only restraints are a slow pay insurance system filled with paper barriers for people seeking help.

Lastly, on a related matter, our government should never build public housing in a flood plain or below sea level. Private citizens can be stupid if they want, but our government should not be building in these locations.

[daniel Covel]

I don't understand those who say they want to rebuild New Orleans with market incentives. Enterprise zone, homestead, etc. i.e. we should subsidize people who want to live and work in New Orleans

Isn't that thinking backwards? Shouldn't we be taxing people who want to live in New Orleans?

If residents of New Orleans had to pay the full cost of living in New Orleans, wouldnÔøΩt many just remove themselves from harm's way? Wouldn't that make us all better off? What if New Orleans was forced to sell bonds to finance the rebuilding -ÔøΩ bonds paid by future local taxes? Could they sell the bonds or would they have to limit the scope of their rebuilding plans?

Chicago and San Francisco were rebuilt without government incentives. (As far as I know.) Will New Orleans only be rebuilt if we bribe people? What does that tell us about the "real" value of New Orleans?

Next, I think, we must accept some blame for encouraging the now dead and injured to live in a dangerous environment.

For example, could the concentration of poor in New Orleans be explained in part by the geography? Around the country we see the poor gather were land is less desirable. In New Orleans did the poor move into a dangerous environment (low areas of New Orleans) because the government distorted the true costs of living there? (Worse, in the 9th ward the government built housing projects on land that few would consider safe or desirable.)

What do these choices tell us about how poor people value their lives? Are poor people simply stupid or perhaps suicidal? The poor knew that they lived in a risky environment, but they took the risk. Why?

Did they wrongly discount the risk, or did they just gamble with their only real currency ÔøΩ - their lives. Did we offer a gamble some could not refuse - given their risk preferences and alternatives? Don't we do the same with some housing projects across the country? DidnÔøΩt turn of the century immigrants need to balance the chance for advancement and the risks of urban living in a new land?

Aren't we doing more harm then good when we bribe people to the point that they are willing to risk death, over another safer choice - moving? Who truly benefits from the levees? What is the true cost of the levee system when you calculate the potential loss of life when they break?

Clearly the low sections of New Orleans should not be rebuilt. Absent expensive government subsidies, few in their right mind would live there. Why should we spend billions to encourage poor people to risk their lives, when cheaper safer alternatives are available?
If New Orleans produced some externality for the rest of the country, we might want to subsidize the rebuilding of parts of New Orleans. But the reality is that New Orleans had a murder rate almost ten times the national average. The middle class of New Orleans was fleeing a flood of crime and poverty long before Katrina. The French Quarter is ok, but I donÔøΩt see spending 200 billion so my daughter can collect beads on Bourbon Street.

If anything the externalities of New Orleans on the delta could be negative.

New Orleans may, absent huge federal dollars, become a new version of old Vegas. A city designed for people just passing through. And what is wrong with that?

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