Self-Interest & A Banking Moral Hazard

Self-Interest & A Banking Moral Hazard

I have not really read into or studied the financial crisis of 2008, but I remember how angry and furious so many people were at the time. There was an incredible amount of anger at big banks, especially when executives at big banks began to receive massive bonuses while many people in the country lost their homes and had trouble rebounding from the worst parts of the recession. The anger at banks spilled into the Occupy Wall Street movement, which is still a protest that I only have a hazy understanding of.
While I don’t understand the financial crisis that well, I do believe that I better understand self-interest, thanks to my own personal experience and constantly thinking about Robin Hanson and Kevin Simler’s book The Elephant in the Brain. The argument from Hanson and Simler is that most of us don’t actually have really strong beliefs about most aspects of the world. For most topics, the beliefs we have are usually subservient to our own self-interest, to the things we want that would give us more money, more prestige, and more social status. When you apply this filter retroactively to the financial crisis of 2008, some of the arguments shift, and I feel that I am able to better understand some of what took place in terms of rhetoric coming out of the crisis.
In Risk Savvy, published in 2014, Gerd Gigerenzer wrote about the big banks. He wrote about the way that bankers argued for limited regulation and intervention from states, suggesting that a fee market was necessary for a successful banking sector that could fund innovation and fuel the economy. However, banks realized that in the event of a major banking crisis, all banks would be in trouble, and dramatic government action would be needed to save the biggest banks and prevent a catastrophic collapse. “Profits are pocketed by executives, and losses are compensated by taxpayers. That is not exactly a free market – it’s a moral hazard,” writes Gigerenzer.
Banks, like the individuals who work for and comprise them, are self-interested. They don’t want to be regulated and have too many authorities limiting their business enterprises. At the same time, they don’t want to be held responsible for their actions. Banks took on increasingly risky and unsound financial loans, recognizing that if everyone was engaged in the same harmful lending practice, that it wouldn’t just be a single bank that went bust, but all of them. They argued for a free market before the crash, because a free market with limited intervention was in their self-interest, not because they had high minded ideological beliefs. After the crash, when all banks risked failure, the largest banks pleaded for bail outs, arguing that they were necessary to prevent further economic disaster. Counter to their free-market arguments of before, the banks favored bail-outs that were clearly in their self-interest during the crisis. Their high minded ideology of a free market was out the window.
Gigerenzer’s quote was meant to focus more on the moral hazard dimension of bailing out banks that take on too many risky loans, but for me, someone who just doesn’t fully understand banking the way I do healthcare or other political science topics, what is more obvious in his quote is the role of self-interest, and how we try to frame our arguments to hide the ways we act on little more than self-interest. A moral hazard, where we benefit by pushing risk onto others is just one example of how individual self-interest can be negative when multiplied across society. Tragedy of the commons, bank runs, and social signaling are all other examples where our self-interest can be problematic when layered up to larger societal levels.
Markets and Fairness

Markets and Fairness

Research from Daniel Kahneman’s book Thinking Fast and Slow may help explain some of the anger and anti-capitalism sentiment that has cropped up in the United States in the last several years. Senator Bernie Sanders is incredibly popular among a segment of the population and he is not afraid to categorize himself as anti-capitalist and as a socialist to a degree that would have been unthinkable just a decade ago. From my perspective, many people feel that they have been treated unfairly by markets, and this lack of fairness contributes to the Sanders support, especially among young people.

 

Kahneman’s writes, “a basic rule of fairness, we found, is that the exploitation of market power to impose losses on others in unacceptable.”

 

My experience is that people are feeling the forces of market power in many different areas, and becoming discontent with their own economic standing and with feeling as though they are being treated unfairly by large market players. It may be that most people can still afford to buy more than what they need and to live comfortably, but on a daily basis they are faced with a barrage of unfair market practices. There may not be anything legally wrong with a market practice, and the market practice may be adjusting for real value rather than just collecting rents, but nevertheless, the exploitation of market power still feels unfair.

 

I spend a lot of time thinking about healthcare in the United States, and for many years the costs of healthcare and health insurance has risen much quicker than employee wages. With employees feeling their wages stagnate, unfair exploitation of market power can become a major outrage. This has been seen with drug prices as some individuals and companies have specifically targeted pharmaceutical mergers and acquisitions with the intention of increasing drug prices. Some medications have risen dramatically in price at the same time that many deductibles for health plans have shot up beyond the savings levels of most Americans. Even though a drug may provide an incredible value like saving a life or dramatically improving the quality of a life, an increase in price while wages stagnate feels deeply unfair to people. This could be a basis for our discontent with markets and capitalism (at least on the healthcare front), and a source of support for Bernie Sanders and his socialism lean.

 

When I think about it, I see this type of market exploitation beyond the world of healthcare. Ice cream cartons continually get smaller, the fun-sized candy is a depressingly small size now, good quality razors seem to be unreasonably costly with the cheap alternatives being effectively useless. Outside of smartphones, most markets seem to be providing less value for higher costs, and it is not hard to understand the frustrations that so many people may feel with markets and market solutions, even if they can still afford to live a comfortable lifestyle. For any given firm, exploiting market power is a rational and reasonable thing to do, but for customers, this adds up to an untenable sensation of loss, and a deep feeling that markets are unfair and should not be trusted. In a global market sense, it is as if we face a universal tragedy of the commons problem, but instead of a habitable grazeland being decimated, it is our economic wellbeing that is destabilized as each player in the market flexes more market power to impose marginal losses on each consumer.

Taking More Than Our Share

The desire to use the environment to maximize our personal benefit at the expense of other people’s use of the environment is known as the tragedy of the commons. Senator Cory Booker focuses on the idea behind the tragedy of the commons in his book United and examines what has taken place in his home state New Jersey. Summing up the idea, Booker wrote, “The impulse to take more than you share seems rational, but in reality the consequences can be catastrophic. The unchecked cumulative effect of selfish actions is the loss of the commons—which is, in turn, an immeasurable opportunity lost for generations to come.”

Two big challenges when thinking about our environment have to do with the time scale of the environment and the size of the environment. Our individual actions seem so insignificant in such large and open landscapes as mountain ranges and oceans, but when our actions are combined with the behaviors of millions and billions of people, the human impact is immense. Our environment also experiences changes on time scales in the thousands and millions of years, a time span so large it is difficult for humans to understand. Geological processes take a long time and occur at steady rates of small change. When we combine the vastness of nature with the time scale of geological change, our human minds end up failing to accurately understand, estimate, and predict the dangers of our actions, and that in part leads to the tragedy of the commons.

Our actions now, because the environment operates on such slow time scales, will have lasting impacts on the planet. This means that when we think of our decisions and our use of natural resources today, we must have in mind not just our own benefit, or the benefits of our children, but true impact of our decisions for generations to come. Humans can understand cycles, changes, and impacts that take place on a two to three generation scales, thinking about how our grandparents impact our lives, but it is hard to think more than 100 years down the road and to think about generations that could be impacted by our decisions 500 to 1,000 years from now. The land we use today and the things we put in our oceans today, could shape the lives and futures for people far out from where we are today.

Ultimately, when I think of Booker’s quote I don’t think of a blind conservation of all resources or thwarting capitalism to avoid damaging our planet. Instead, I try to think about my relation to nature. Do I try to take as much as I can in any given situation, even if it is not going to help me? There have been plenty of times that I have eaten more than I needed, only to regret my decisions as I waddled back to my car with a stomach ache. I have had an opportunity to have something for free, and I have taken far more than I needed or could even use, only to have the rest of what I took clutter my house and take up space.

From what I have seen, I don’t have to be a hippie or focus so much on conservationism that I lose all faith in capitalism to protect the planet. I can host a community clean-up and offer prizes for those who participate. I can drive in a more economic way, using less gas, saving my brakes and tires, and prolonging the life of my vehicle, saving money but still doing something that participates in the economy and uses resources. I can focus on recycling, and try to make purchases that limit my plastic use, and none of these decisions take away from my participating in capitalism or make me a stand-offish hippie. They are just small actions, but I know that when combined with the small actions of millions of others, make a large difference.

Preservation of Our Environment

Taking care of our shared spaces and maintaining our environment is not something we do a great job of. Fields, rivers, lakes, and outdoor areas are everyone’s shared responsibility, and because of that, they are no one’s individual responsibility. We will maintain our own lawns or pay people to do our home landscaping, but when it comes to our public outdoor spaces, we often fail to maintain and preserve the land we share. These spaces are expensive to maintain, the threats of invasive species are hard to understand, and it is not clear who should be the person that spends the time and energy taking care of our public places. In political science this dilemma is known as the Tragedy of the Commons, and Cory Booker addresses it in his book United.

 

Booker writes, “We are all dependent on nature, so we all have a stake in the preservation of our environment.” Taking care of our planet is important because it is the only one we have, and it is what sustains our individual lives, our societies, and the only life we know of in the universe. At the same time, taking care of the planet is unclear with ecosystems connected and dependent on each other in complex ways, with connections we are not always able to understand. Scientific research is expanding, but still not at a point where perfect models of natural processes such as rainfall, erosion, or phosphorous cycling are possible. But we depend on what we know about nature, and must continue to push forward and be cautious with how we use nature so that we can maintain what we have for not just our generation’s use, but for the use of future generations.

 

The truth is that we must use nature. We need to extract minerals, metals, and plant based materials from the earth. The physical structures that protect us and allow us to thrive come from what we pull out of the earth. Our medicines are dependent on plants and compounds that plants create, and our smartphones rely on rare elements mined form across the planet. Our dependence and demand for what the earth has to provide is very real and feels much larger than any one individual, making our personal responsibility feel tiny in comparison. Nevertheless, it is important that we use what the earth has to provide in a rational and reasonable manner, recycling what we can, eliminating waste when possible, and constantly striving to take things from the planet in the least disruptive manner. This responsibility is difficult and expensive, which is why the commons are ignored leading to the tragedy they face. We must understand that pollution, imbalanced extraction, and continued consumption do have costs that are greater than their immediate benefits, even if we only see the benefits now and can’t understand the costs of the future.