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.

Harvard marketing professor Anita Elberse has conducted a study which seems to reveal that customer purchasing behavior with regard to hits is the same online as it is offline. In her Harvard Business Review article, she reports:

For Chris Anderson, the strategic implications of the digital environment seem clear. “The companies that will prosper,” he declares, “will be those that switch out of lowest-common-denominator mode and figure out how to address niches.” But my research indicates otherwise. Although no one disputes the lengthening of the tail (clearly, more obscure products are being made available for purchase every day), the tail is likely to be extremely flat and populated by titles that are mostly a diversion for consumers whose appetite for true blockbusters continues to grow. It is therefore highly disputable that much money can be made in the tail. In sales of both videos and recorded music—in many ways the perfect products to test the long-tail theory—we see that hits are and probably will remain dominant. That is the reality that should inform retailers as they struggle to offer their customers a satisfying assortment cost-efficiently. And it’s the unavoidable challenge to producers. The companies that will prosper are the ones most capable of capitalizing on individual best sellers.

Chris Anderson, the author of the book The Long Tail, responds to the article on his blog. He argues that her different results are due to differing definitions of “head” and “tail”.