Moral Hazard

Goodness, I just lent $283 to a private insurance company. And so do you and so did 299,999,998 other people, for a total of $85 billion.

"Moral hazard" is the economists' term for the force that causes the strange behavior that people may exhibit when they know that they are shielded from risk. If you're the CEO of a giant company, and you're thinking about making a risky investment, it's one thing if you think, "if this goes well, we make a lot of money, and if it goes badly we could lose the whole company," whereas it's another thing if you think, "if this goes well, we make a lot of money, and if it goes badly, the taxpayers will bail us out." Obviously, you're a lot more likely to take the plunge if you can count on the latter scenario.

So the government needs to be careful before it bails out big companies that have made bad decisions. It just encourages more and riskier behavior in the future.

As usual, I can't pretend to know whether bailing out A.I.G. was a good idea. I'm guessing most people, including those who did it, don't really know either. Perhaps A.I.G. was "too big to fail," perhaps not. But if taxpayer money is implicitly on the hook every time a really big company makes a risky investment decision, then CEOs are just going to take more and more risk.