The Erosion of Individual Responsibility-BECKER

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 “teaser “ 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.

Comments

[Jim]

Re:Suicide

Fascinating analysis. Thank you.

Perhaps we should do the analog. Wouldn't it make economic sense to remove the artificial checks, both physical and social, on evolutionary forces? Why treat diabetes? That entire gene pool would disappear in several generations. Why discourage foolish risky behaviors? Accidents would take care of most of those in a few years. Who knows; if we stop propping up genetic and social weaknesses, the value of life might increase and suicides would disappear.

Malthus was right. He just didn't have the right analytic tools.

[Fred Press]

Gary,

That was a great piece you did in the Journal this weekend. I address many similar issues in my recently published What Greenspan Can't Tell You: The Inner Workings of the Investment Markets. I strongly recommend that you and readers of your blog take a look at my work.

Best,
Fred Press

[Greg]

I just read an excerpt of this post in The Wall Street Journal. Unfortunately, they left out the part where Mr. Becker questions the merits of the Fed's Bear Sterns bailout. The journal stressed the "moral" arguments, and not the practical ones.

As a taxpayer, I think the Fed should've bought bear Sterns itself, then sold its assets and at least made the American people some money, instead of helping JPM Chase and making Jamie Dimon look like a "genius" and letting the taxpayer take the risk. Some genius...I almost took out a home equity line and tried to buy Bear myself at that price!

As for moral hazard, a Bear bankruptcy would've been a much better lesson. Alas, the uniqueness of the banking industry makes it unlike others in that a large failure affects all citizens and all industries because of the nature of its assets as a medium of exchange..it's not like a car company going bust.

So, all banks that want to recieve help from the Fed should be subject to capital reserve requirements and Fed inspection. Otherwise they should get no help. And Americans with good credit should then be able to borrow directly from the Fed and let the banks be damned...I'd rather borrow fellow taxpayer money anyway.

One of the tennants of our time is the mistake in believing that "slicing" and spreading risk is a reduction in risk....actually, spreading risk to many parties that may all default is worse than having a handful of institutions bearing a large majority of risk.

But I have to say I don't buy the argument that individuals are "shifting responsibility to others." This is basically a media myth. Becker is right to criticize it but he shouldn't believe people actually think it. I have a hard time believing that subprime borrowers were suckered into loans and are trying to throw the blame now. This is just a news story to make people feel good.

In fact, as many have observed, they bought "mortgage options" that mostly ended up out of the money, as options usually do...they also did it with no money down...they were perfect arbitraguers! Take a free gamble on a house..if the price goes up I win, if the price goes down i walk away and the bank loses...No, we shouldn't waste our time thinking that we are facing a society where individuals are shifting responsibility to others....in fact, they were being smart- they knew they had little to lose and that the government would probably bail them out since so many people were doing it. I give them more credit than Becker seems to.

We live in a time when leverage equals success...how else could hedge funds charge two and twenty and people still think them good investments? Individual homeowners were just following the same trend...lever up and be somebody!

So now we're faced with the options of mass bankruptcy or inflating our way out of the situation...Looks like the Fed has chosen the latter. I just feel bad for all those "moral suckers" who actually saved their money to wait for a time when house prices would fall so they could get a good bargain. They might be very responsible individuals, but now they'll miss out on the government bail out while prices will remain inflated.

[Greg]

I guess a quick way to some up my rant above about moral hazard is to say that we should not lose sight of the difference between morality and rationality.

Over-leveraged subprime borrowers with no money down were acting rationally, not morally.

Rationality is for the field of economics, while morality is for the field of religion. In fact, I'm wondering how often it is the case that acting morally is a rational decision. I guess I should consult Adam Smith.

[LCSusan]

As a person who lost my home to foreclosure several years ago, I can certainly empathize with those who may now be facing foreclosure. However, despite the horrendous pain, shame and guilt, I can truly say that no lesson was ever better learned than the one taught to me and my blameless son when we had to leave our home. As mean spirited as it may sound, there are very, very, very few home owners who deserve help from the government, the rest should just have to learn that hard lesson.

http://strictlyanecdotal.com/2008/03/22/the-american-public-deserves-some-straight-talk.aspx

[Jack]

Jim....... it's important to remember that evolution is not the 'survival of the fittest' but the survival of those fit enough to attract a mate and pass on their DNA.

What sort of "social weaknesses" do you think "we" are enabling prior to mating season?

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

Why treat diabetes? That entire gene pool would disappear in several generations. Why discourage foolish risky behaviors? Accidents would take care of most of those in a few years. Who knows; if we stop propping up genetic and social weaknesses, the value of life might increase and suicides would disappear.

[Jack]

Jim....... it's important to remember that evolution is not the 'survival of the fittest' but the survival of those fit enough to attract a mate and pass on their DNA.

What sort of "social weaknesses" do you think "we" are enabling prior to mating season?

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

Why treat diabetes? That entire gene pool would disappear in several generations. Why discourage foolish risky behaviors? Accidents would take care of most of those in a few years. Who knows; if we stop propping up genetic and social weaknesses, the value of life might increase and suicides would disappear.

[Jack]

As the thread winds down, it still appears that more calls for "responsibility" are being hurled at those doing the borrowing, than those doing the lending.

Considering that those doing the lending are lending the money of others, have we forgotten that they used to have prudent standards? and in the quest for commissions have they also forgotten prudence in lending?

[noname]

Removing freedom/autonomy from smokers is problematic. See

http://medicine.plosjournals.org/perlserv/?request=get-document&doi=10.1371%2Fjournal.pmed.0040185

Also, comitting suicide may be beneficial for very unhappy suicide attempters.

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