Moral Hazard

Moral hazard: when people just aren’t incentivized to be nice. Moral hazard is when one party enters a transaction with ill will, knowingly providing false information, bluffing promises, or in some way not following the contract or agreement.

What kind of incentives would cause people to be such assholes to one another? Looking at the 2008 banking crisis provides some anecdotal examples. The incentive for money underlies everything, but what else is going on? If people aren’t going to get in trouble or be held accountable if they’re caught, then they’re more likely to do it. That’s why many people were mad about the government bailing out the banks: it signalled to big banks that it’s okay to mess with consumers, because the government (and ultimately, taxpayers) will foot the bill for their mess once their scheme falls apart. Yet, not bailing out the banks would have meant many Americans were screwed over in their personal finances.

Another reason has to do with institutional norms and incentives. One particular bank that rhymes with Shmelz Fartgo got in trouble because leadership set employee quotas for new accounts so high that employees started opening new accounts in customers’ names without the customers’ knowledge or consent (which, you know, is basically identity theft and fraud). If an employee didn’t meet their quota, they’d just be replaced by someone else, so moral hazard was high.

Keep an eye on moral hazard when dealing with contracts. It’s an immoral world out there.