Strong opinions, weakly held

Tom Vanderwell on moral hazard

Paul Kedrosky has a guest post from Tom Vanderwell on moral hazard. Moral hazard describes a situation where parties behave differently because they do not expect to bear the full consequences of their actions. For example, when a guy in a bar acts especially belligerent because he’s got his big, tough friend with him, that’s moral hazard at work.

Free market purists argue that moral hazard distorts the free market, and so firms and investors should not be insulated from risk. In other words, the FDIC should not exist, because then the risk of bank default would force customers to be more informed about the loans their banks make. This would cause banks who make risky loans to lose business, and thus strengthen the banking industry.

Of course, there are reasons why we protect people from the consequences of risk, even if it introduces moral hazard to the equation. Only rarely do only the people taking on unwise risks suffer the consequences when their bets don’t pay off, which leads Vanderwell to this question:

But how can we prevent a total meltdown of the housing and mortgage market (what would happen if Fannie and Freddie actually went under) without absolving some of the participants (for this particular discussion, we’ll limit it to Wall St., the Ratings Agencies, the Mortgage Companies, and the Banks who wrote the loans oh, and the mortgage lenders themselves if they did anything criminal or fraudlent) of at least some of their consequences?

He has some suggestions.

Needless to say, moral hazard is a concept that is of great interest to insurers. Malcolm Gladwell wrote an article in 2005 explaining why moral hazard isn’t really a concern when it comes to health insurance.


  1. the Gladwell link is awesome — one of the most revealing pieces on health care I’ve seen. thanks for the link.

  2. I have thought that bailouts should be coupled with board expulsion, but he takes the insightful and necessary next step of hurting the investors as well.

    Nice find.

  3. While I loved the Vanderwell stuff, Gladwell, who I usually enjoy, failed to deliver for me here.

    In the course of Gladwell’s argument, he cites the RAND study’s findings that people with access to less health care suffer worse rates of hypertension. This example grossly misrepresented the RAND study, which principally concluded that access to more health care does not improve health outcomes.

    Now, Gladwell is right in one sense, blood pressure was one exception (vision was the other) across 30 measures. But finding p 0.03 in across so many measures is pretty well covered by chance.

    It really reads like Gladwell was data mining to flip the accepted result of this major study, which directly contradicts his point.

    Gladwell says the real problem is that we aren’t very good at figuring out what health care is necessary and what care is frivolous. But even if that were true (despite RAND’s findings), it cuts both ways, against Gladwell’s argument as well as for it. It suggests that as you allow people more medical care, they don’t just spend on necessary care first, they waste more on frivolous care at the same time.

    I think Gladwell’s characterization of the research is wildly off the mark, but he’s a smart guy and a clever writer, so let’s suppose I’m wrong. Even if Gladwell is right, we’re still faced with a troubling dilemma, maybe best illustrated in the extreme: how many “healing power of crystals” sessions should we pay for if it gets one more person to get a colonoscopy?

    At best, Gladwell has just deemphasized moral hazard in the medical industry. At worst, Gladwell’s academic integrity looks a little suspect.

    (Overcoming Bias had a piece on RAND here which informed some of my conclusions.)

  4. I dunno, Thom — a 10% reduced risk of dying among higher-risk patients doesn’t seem like something one should disregard. That’s pretty significant, and certainly would be enough to change standard medical protocol…

  5. Also, there’s nothing there about the third case, which is having no insurance. At best, the lack of difference seen in the RAND study might indicate that co-pays are valuable, but they don’t really say that universal healthcare is a bad idea, because they don’t really address the case that can’t afford a trip to the dentist (as well as food and rent) and thus risks death by sepsis (as happened a couple of times here in PA recently)…

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