Hardly a day goes by during this housing crisis that the media does not report on families in foreclosure proceedings, or in arrears in repayment on mortgages that had close to zero down payment requirements and low ‚Äúteaser ‚Äú interest rates. The many excuses offered by some home owners for their plight, and also eagerly by the authors of these human interest stories, is that the borrowers did not understand that these introductory interest rates might rise a lot after a few years, or that they would have negative equity in their homes if housing prices stopped rising and began to fall. An obvious alternative explanation for their behavior is that they gambled that the good times would continue indefinitely.
This type of response to failed decisions is not unique to the present housing crisis, but is part of a strong trend toward shifting responsibility to others. Women who sign a pre-nuptial agreement specifying the amount of their husband's pre-marital wealth that would be theirs in the event of divorce often try to have the agreements overthrown in divorce litigation. They claim that they did not understand what the agreements meant, or that their husbands took advantage of them in other ways to get them to sign the agreements. Usually they signed simply because that was the only way they could marry the men they very much wanted to marry, perhaps in part because the men were wealthy.
Many criminals who confess to or are convicted of serious crimes try to have the courts excuse or mitigate their behavior. They allege that they had uncaring or abusive parents, or that fathers, relatives, stepfathers, or other adults molested them as children. Abusive treatment is awful, but still the vast majority of children abused do become law-abiding and responsible adults. That is a major fact that courts should pay attention to.
Successful attempts to shift the responsibility for bad decisions toward others and to society more generally create a "moral hazard" in behavior. If individuals are not held accountable for decisions and actions that harm themselves or others, they have less incentive to act responsibly in the first place since they will escape some or all of the bad consequences of their actions. It does not matter greatly whether this moral hazard resulted from the shifting of blame for unsuccessful actions to the "small print" in a contract, to an abused childhood, to a mental state, or to many other efforts to shift responsibility away from oneself.
An important foundation of the philosophy behind the arguments for private enterprise, free economies, and free societies more generally, is that these societies rely on and require individual decision-making and responsibility. This philosophy not only emphasizes the moral hazard reasons to require individual responsibility, but also "the use it or lose it principle", a colloquial expression indicating that various mental and physical capacities wear down and erode if they are not used on a regular basis. This principle implies that people who are accustomed to having other persons or governments make their decisions for them lose the ability to make good decisions for themselves. Free societies lead to better decision-making partly because men and women accumulate more experience at making decisions that affect their well-being and that of others.
Of course, I recognize that not all individuals are equally capable of making decisions in their own interests. Clearly, the mentally retarded have trouble understanding complicated decisions. People sometimes get fooled by how contracts and transactions are presented to them, perhaps because of cognitive quirks. College-educated persons generally manage their financial assets better, and respond more successfully to many types of economic, health, and other stresses, than persons with less schooling. For example, educated residents of New Orleans reacted more effectively to the challenge of the Katrina hurricane than did high school dropouts. Similarly, the anarchy in Russia following the collapse of communism greatly lowered the life expectancy of all Russian men except those men with a college education. These men continued to improve their life expectancy throughout the economic crisis that engulfed Russia.
Still, greater practice in making decisions, and greater responsibility for the consequences of one's decisions, usually significantly improves decision-making by the vast majority of adults, regardless of limitations in their education and cognition. Moreover, many of the decisions and actions that do not work out well are not due to low education, inability to understand what is going on, or biased and incorrect information. For example, the sub prime mess that continues to devastate financial institutions of the United States and elsewhere is not due to the limited information given to borrowers since this crisis has also financially ruined many highly educated and sophisticated bankers, hedge fund managers, and others with years of experience dealing with complicated financial assets. Borrower and lender alike, regardless of their financial experience, were caught up in the atmosphere brought on by a bubble that seemed to promise perpetual good times in financial markets.
What if anything should governments do to help out in this present financial crisis, mindful of the many kinds of moral hazard that are lurking, but also mindful that the financial structure is delicately balanced? Despite the moral hazard risks, interventionist policies might be justified not because some borrowers or lenders were taken advantage of, but if these interventions would help the economy recover more quickly, and insure that the recession is neither prolonged nor deep. Still it is difficult to see the merits in the Fed's efforts to help the sale of Bears Stearns to JPMorgan Chase by guaranteeing many billions of mortgage and other assets of the company.