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Moral Hazard

In accordance with the pretty lady’s wishes expressed at the end of the video, I am spreading her words.

The moral hazard is a real thing in everyday life. In case she wasn’t clear enough in the video I’ll provide a few more examples. (not all of them are example OF a moral hazard, some are examples of measures taken to avoid it.)

1. If the government will bailout companies of a certain size if they threaten to go belly up, more companies, of a certain size, will be more willing to (and will) engage in risky business practices and/or give away the farm to unions and executives.

2. If you wish to have no deductible on you car insurance, the company will charge you significantly higher rates. Typically you would spend more money in the long term to offset the possibility of having to pay a large deductible suddenly in the future.

3. Insurance companies do not generally insure against crimes committed by the policy holder (my business insurance does insure against employee theft and crimes, but that’s not the same thing). Ex. you homeowners policy may insure against arson, but not if you are the arsonist in question.

4. Lending money to people who show no realistic ability to pay it back, bundling them together and selling them to the government (as the pretty lady says) is a classic moral hazard. You do something and someone else feels all the consequences, that’s the gimmick, in a nutshell.

5. People jump out of airplanes. There is a significant risk of smacking into the ground when you do this. If they have a parachute, and they judge the risk of the parachute not catching them to be low enough, they will jump. When you could find a way to make someone else do the smacking if your parachute doesn’t open, you would have a near perfect moral hazard, there would be no reason not to jump.

The fact is when you do something, anything, the consequences directly effect your behavior. If you are insulated from all of the risk the average person is not going to care about the odds. Our ancestors went out hunting mammoths because they judged risk of being gored by a giant hairy elephant beast to be lower than the risk of starving. However they needed to come up with ways to make the equation work. (Admittedly I bet mammoth tasted better than what they were otherwise eating, but that only plays into the equation further. How much risk is an acceptable amount for the benefits gained from success?)

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