Lead us not into Moral Hazard

When the penalty for the marginal bit of immoral behavior is low, it increases the hazard of immorality – i.e., the likelihood that it will occur. In the wilderness, with only a knife and your wits to keep you, intense and relentless virtue is the only option. The constraints on your behavior are inescapably, painfully apparent. When you are wealthy, the hedonic penalty of imprudence is lessened. This is why prosperity – the situation that obtains when we control enough wealth that the marginal imprudence is apparently not at all threatening to our basic welfare – can be the seedbed of moral disaster.

Prosperity is a reliable sequela of virtue. So the discipline of the wilderness, or of hard times, can engender great wealth. Yet such wealth does not then necessarily result in improvidence, or a tendency toward moral corruption. Where the rewards to virtue and the penalties to vice are not obscured by noise in the system of the economy – when failure is not coddled, or success derogated – rational agents can more readily guide their acts toward appropriate ends. And since the most rational and intelligent agents always end up controlling most of the resources, and therefore making the most consequential economic decisions, a preponderance of virtue and knowledge among them can guide the whole system in such a way as to keep it predominantly within the constraints of prudence.

But when noise is introduced to the economic system, it misguides even rational intelligent agents, inclining them to vicious ways. Catastrophe then ensues.

For example, when the ECB and the EMU intervened in the natural cultures of Europe in such a way as artificially to depress the interest rates they were paying, it increased their moral hazard. Take Greece. The Greeks had an inveterate habit of inflating the drachma to monetize their imprudent borrowing. They therefore suffered higher interest rates than they otherwise would have. In 1993, the cost of capital for Greek borrowers was about 25% per year. Over the course of the 90’s, as Europe was moving toward monetary union, and thanks to the boom of the 80’s and 90’s, Greece improved her credit-worthiness so that by 1999, when the Euro was born, her cost of capital was close to those of other European countries. It fell to about 5% per year when she adopted the Euro in 2000.

Loosed from the constraints imposed by high interest rates, the Greeks proceeded to spend money like sailors on shore leave. Nevertheless their interest rates stayed low and stable through most of the next ten years. Why? Because at the lower interest rates engendered by the Euro, their economy could service more debt. So they borrowed up to and then beyond the limit of what their real production of economic goods could service. They became insolvent. Other European nations did the same. The United States is now a juggernaut moving faster and faster in the same direction.

The global crisis of 2008 was the recognition by markets that they had been misled about the true risks posed by debtors via massive state distortions to nominal interest rates. As soon as the real risks became apparent, investors instantly translated the cost of capital to Greeks to about 16% per year. This translation was an effectual, massive devaluation of the already existing corpus of Greek debt, denominated in Euros, and with nominal interest rates wildly lower than what would be required to compensate investors for the true risk of loaning money to Greece. The holders of those Greek bonds saw their balance sheets turn upside down as their bond holdings went down the toilet. They realized that they had less money than they had thought, stopped investing money (i.e., reduced their risk exposures), and economic ruin loomed. Ever since, the Europeans have been engaged in desperate measures to stave off the inevitable day of reckoning.

The amazing chart below tells the story. It displays cost of capital (long term interest rates) in the Eurozone. Its data come from the European Central Bank [ECB], which is to the Euro as the Fed is to the US dollar. There is an important difference between the two banks. The Fed has two contradictory missions: to maintain full employment, whatever that is, and to maintain a stable currency. The ECB does not (yet) have to worry about maintaining full employment in the Eurozone. Markets therefore seemed to feel for a long time that the Euro was unlikely to suffer much inflation. So far they have been right. And this kept interest rates in Euro-denominated loans relatively low, as compared with loans denominated in drachma. If the drachma is inflating at 10%/annum, a lender must charge at least that much just to stay even.

Before the intervention, the market constrained notorious Greek impecunity by charging Greeks higher interest than Germans. One result was a constraint on the economic development of Greece; but another was a constraint on the amount of trouble Greece might generate.

When U.S. banking authorities did the same thing with mortgages, the same thing happened in the real estate market.

The noise introduced to the economic system by these state interventions prevented it from responding appropriately to reality. They prevented economic agents from understanding the true consequences of their actions, so that they became more likely to behave imprudently. The noise obscured the truth, and that increased moral hazard. Behavior pushed toward its proper limit; thanks to the noise, it pushed beyond.

There is a principle at work here that is a type of a general principle in nature. We all refer to a different type of that same archetypal principle when we say, “work expands to exceed the available time.” Its financial version is, “the schedule of apparently important expenditures expands to exceed the available funds/economic resources.” The Second Law of Thermodynamics is perhaps the most pervasive type of the archetypal principle (except that with the Second Law, the budget of the system under consideration cannot ever exceed the supply of available energy – cannot borrow, or give, or cheat – the way that it can in human affairs).

What is the archetypal principle? Things seek their proper limit, and do not rest until they find it.

I saw this with my own kids. When I was a new and tentative father, my kids misbehaved more and were less happy. When I made the behavioral limits clear, and enforced them sternly, they settled down and were, not just well-behaved, but happier, less anxious about where they truly stood in the world. And this liberated their energies for creative work: for playing, learning, and developing. Fortunately for all of us, my wife and I figured this out when our eldest was only about two. [I note for the record that my wife was the one who mostly figured this out, and came up with most of the sensible ideas about what the limits should be. My contribution consisted mostly in looming with immense and imponderable power to destroy or to save, to condemn or to bless. A rumble from my direction, and the young nomads of my household trembled: if of thunder, with terror; if of laughter, with joy.]

Here’s a question: if a thing has not reached its proper limit, can it rest? Is that really possible? I am reminded of Augustine: “Our hearts are restless, Lord, until they find their rest in thee.”

“Lead us not into temptation,” then, can be understood to mean simply, “help us apprehend the Limit.” Thus the Psalmist’s endlessly reiterated prayer that YHWH show us his Way, and write his Law in our hearts.

11 thoughts on “Lead us not into Moral Hazard

  1. The noise is destiny. Human beings are made for tiny groups of hunter gatherers. Not 7 billion people. Even agricultural societies and their traditions were based around the idea that 95%+ of the population farmed and easily understood physical commodities made up most of economic trade. A far cry from 2% of the population farming and the economy mostly made up of ephemeral services of hard to define value. Noise is the destiny of size and complexity. Even if our government did a better job that would still be true.

    • There’s a big difference between destiny and fate. Fate cancels destiny, plain and simple. The caterpillar’s destiny is a butterfly, but it’s fate could be bird-food. Don’t confuse them. Destiny is what God gives you; fate is of the devil.

      • @Ilion – I think this is factually incorrect: in the examples I know of, hunter gatherers do not want to settle, and indeed often have great difficulty in taking up farming. Usually H-Gs are killed or enslaved by Agriculturalists – they seldom assimilate.

        Probably there is a need for evolutionary adaptation before H-Gs can live successfully in agricultural societies.

    • asdf, your comment struck a chord with me. I have been teaching in a small Christian boarding school in a very tiny town down South for the past 8 years. Having taught hundreds of white middle class kids, and urban blacks, and country blacks, and lots and lots of rednecks, I can tell you this with certainty: Most people are meant to be peasants. I don’t use the word “peasant” in a pejorative sense. It is simply an observation on my part. A love of reading, and the subsequent linear logic that reading imparts, is absent in the vast majority of teenage Americans. Linear, sequential logic is the touchstone of Western civilization, and without it one must come up with another way of making a living. One hundred years ago our southern lads would have dropped out of school after the sixth grade, and gone to work on the farm, or on a fishing boat, or in a steel foundry, or in a lumber yard, or you name it. However, the past one hundred years of egalitarian nonsense has trained all of our young men (no matter how average) that they are too good for manual labor.

      Until our nation understands that most of us are not destined for Wall Street, academia, or a law office, we will continue to have healthy and strong twenty-somethings living on welfare and pining for the day they will become famous athletes or rappers.

      A return to the land is necessary. In fact, whenever I have a good-hearted young man in my classes whose father owns a farm I always encourage the boy to do whatever it takes to maximize his usefulness on the farm. I never encourage him to go to college for the purpose of getting away from the land. However, the black kids are a special case. They simply will not consider farming. The “noise” that they hear makes it impossible for them to understand that there is a limit to the free money being printed on their behalf.

  2. Everything you–and the rest–are saying might be right. But consider some additional implications of what you are saying: “Where the rewards to virtue and the penalties to vice are not obscured by noise in the system of the economy – when failure is not coddled, or success derogated – rational agents can more readily guide their acts toward appropriate ends. ” This is too optimistic about human nature. It assumes that the central guiding motive of intelligent, resourceful, hardworking, canny people is reliably the desire to produce something of value that contributes to the common good–and if we just unleash their creativity the common good will be reliably fostered. I believe there are plenty of such people. There are also plenty of people whose motive for their hard work, is the desire to glorify the self–to seek material comfort for the self, and to revel in the feeling that they are better than others. By that, I don’t mean, a just appreciation of their own success and virtue. Rather, I mean the sin of pride–which I think can be defined as the step beyond the just appreciation of one’s own real accomplishments into something else entirely–an enjoyment of the fact that I have accomplished WHAT OTHERS HAVE NOT, that I possess WHAT OTHERS DO NOT POSSESS, That they lack what I have. This is by definition an enjoyment of and desire for nonbeing and as such is the essence of sin. These two aspects (incontinence and pride) of human nature are the essence of selfishness which from a Christian perspective is the essence of sin. Your comments amount to a defense of capitalism. And I agree that capitalism is defensible. But I think you go too far. You have an assurance that if intelligent, canny, hardworking people are just allowed to succeed economically to the best of their ability, that will reliably produce a society that can be said to foster the common good. Historically, that has happened to a large extent. But it is also true that it has happened in the context not of pure capitalism, but of regulated capitalism, and capitalism in tandem with the labor movement. Whether regulation and the labor movement have been essential to the emergence of a broad based middle class over the past 200 years is open to question. I think it has. You may disagree. But that is in fact the historical record which must be accounted for. What I am saying is that in fact the development of capitalism has fostered the common good–but there is no reason to feel assured that this will continue into the indefinite future. For the selfishness that capitalism does also foster is a threat the to common good. Here is how I see it: modern western capitalist civilization is really playing with fire. Fire can be a force for good, or also for destruction. Modern technology, business organization, capitalist competition, can be a force for good–but it also opens up extraordinary dangers. Our civilization is pursuing a high risk course. (The existence of nuclear power and nuclear weapons being simply the most obvious example.) That is no reason to reject or condemn it. There is no such thing as great achievement without great risk. But that risk is real. And it seems to me that you do not acknowledge that risk. It is the risk which goes with the fallenness of our human nature, which as for example Dante and Aquinas clearly saw, we can see in the constant temptations of lusts of every form, and more dangerously, of pride.

    Another way to look at this question is this: You affirm that there is some sense in which society should guarantee that humans receive what they justly deserve. But there is a huge question this leaves open. This is a whole considerably bigger than the one of which it said you could drive a truck through it. What is the just reward for what? There is simply no way to objectively answer this question. Are we to say, that whatever rewards individuals are granted by their particular societies are in fact just? Are we to say that the operation of the market in fact reliably distributes rewards that are objectively just? This, I submit, is absurd. For example, our market is based upon selling things. What things sell? The things people want. So the people who produce things that people want are the ones who are going to be most successful. But this is to reject the something taught by the whole tradition of Western Christian thought. Because, according to this tradition–starting with its precursors Plato and Aristotle, and then extending to Augustine and Aquinas etc–the fact that people desire something is in no sense a sure sign that what they desire is good. This more or less proves that the marketplace cannot be said to simply determine which products or activities are of the greatest genuine inherent value. I think it pretty much follows that there really can be no objective standard for determining what are the rewards that which people “really” deserve. I don’t think that this means that questions of distributive justice are therefore meaningless or not amenable to rational discussion. But it does mean that there is no set of statable, abstract, definite criteria that can be used to answer questions of distributive justice. Also, I believe the bedrock of the Christian love ethic is at least this: Certainly not that everyone should recieve the same rewards. But on the other hand, as both John Paul II and Martin Luther King have affirmed, that, given the actual level of available resources– there is a certain minimum that each society is morally required to provide all of its members. I have the impression that you deny this last proposition. Do you?

  3. I need to add a qualification to my response. For you did say: “And since the most rational and intelligent agents always end up controlling most of the resources, and therefore making the most consequential economic decisions, a preponderance of virtue and knowledge among them can guide the whole system in such a way as to keep it predominantly within the constraints of prudence.” You did not say that “a preponderance of virtue and knowledge among them CAN guide the whole system.” You did not say that there necessarily will be a preponderance of virtue and knowledge among the most rational and intelligent agents. And you did not say that even in that case the system will necessarily be guided in a prudent way. Am I correct in assuming that you do not in fact equate “rationality and intelligence” with virtue and knowledge? Part of my argument rests on the assumption that they are not necessarily the same. I.e. that rational and intelligent people are not necessarily virtuous, that rationality and intelligence are just not the same as virtue and do not necessarily lead to it. So I am asking about the relation of all this to the question of the what Christian moral theology should conclude about the moral status of modern industrial capitalism. It occurs to me that you may in fact share my position that there is no guarantee that the winners in a capitalist system will necessarily be virtuous, and that is why religion needs to be an independent cultural force. And that capitalism without Christianity may indeed be subject to the dangers I outline. But if that is so, then what does Christian moral theology have to say about the shape that a capitalist society should take? Doesn’t it imply that Christian ethics itself implies a kind of restraint laid upon capitalism?

  4. Jeremy,

    I love your post. Didn’t really want to take the effort to say basically the same thing myself and you’ve done it well.

    “But if that is so, then what does Christian moral theology have to say about the shape that a capitalist society should take?”

    I don’t know. The problem with modern economies is the correct answers are very hard to know. Its all covered in noise. Is Obamacare the manifestation of the Christian desire to provide for the sick or a 2,000 page monstrosity written by special interests that will cause net harm? I work on it directly and I can’t tell.

    Let’s say, like me, you believe it’s a net evil. However, you know single payer is a net good. And you think there is a possibility that the nature of Obamacare will backdoor single payer one day. Is it now a net good? Is there some back of the envelop probability at which the net evil of Obamacare is overtaken by the net positive of it backdoor single payer? What is that number? Does Obamacare cross the threshold?

    Do you vote for some politicians who publicly say they support it? What if you think they are lying? What if they support other policies you don’t agree with?

    These decisions are practically impossible. That’s what modern economic leads to, difficult decisions that are almost impossible to make. And as you point out in your post even the libertarian idea of simply not making any rules doesn’t necessarily get rid of the noise either.

    • >“But if that is so, then what does Christian moral theology
      > have to say about the shape that a capitalist society should take?”

      The Bible does not make very specific instructions about the economic system, I think that it leaves some room of manouver here. It does make some basic requirements:

      *Private property should exist and stealing should be out-lawed
      *The Government may collect taxes

      > Let’s say, like me, you believe it’s a net evil. However,
      > you know single payer is a net good. And you think there
      > is a possibility that the nature of Obamacare will backdoor
      > single payer one day. Is it now a net good?

      Aha, been there, done that, and I wouldn’t recommend it to anyone… I once in my life voted left because I liked some things which they promissed (like fighting corruption and defending the national manufacture) and I hoped that those other things which they are for (pro-gay, anti-white, anti-Christian) would be only be emptyless speach, they wouldn’t actually do those things. Well, oh boy, I couldn’t have been more wrong in my life =) They relentlessly pursued everything which I despise them for and those things which I liked about them passed by as empty speach. And ever since I promissed to never again vote left in my life, and I’m sticking to it.

      > Do you vote for some politicians who publicly say they support it?
      > What if you think they are lying?
      > What if they support other policies you don’t agree with?
      > These decisions are practically impossible.

      They are most surely not impossible. Don’t be so easily defeated. Democracy is complex, and I have studied it for thousands of hours to arrive at my conclusions and I think that I “got it”

      There are only 3 major ideologies in the west:

      *Socialist Liberal -> Combines Marxism with Social Liberalism. Like the Democratic Party
      *Classic Liberal -> like libertarians, against government programs, partially socially liberal
      *Conservative -> Socially Conservative, might differ about government programs: European-style conservatives are in favor of single payer health care, passenger rail, workers rights, etc. USA-style conservatives seam to be against.

      So if you are a true Christian and in favor of government programs like single-payer, then most probably you are a European-style Conservative. There are also true Christians who are libertarians or USA-style conservatives, although I think that they are mistaken, and I think that a true Christian cannot be a Socialist Liberal unless he is most completely ignorant about marxism.

      In most countries what counts in the vote is only the party, so you just need to choose a party which is conservative and vote in it and you will get things right 99% of times.

      In the USA, things are much, much harder, because in the voting system in the USA what counts are the individual candidates, not the party, so you will unfortunately need to analize each candidate.

      In the USA the way I understand it the main election is the primary, should you should always participate in the primaries. The actual election is only a run-off election, to choose which of the top 2 candidates will get actually elected.

      In the primaries I think it is almost impossible that you won’t find someone with whom you agree 90%+. Find this person and vote for him, regardless of his vote %. Study his record to see if he is lying. Study him and try to find out to which of the 3 ideologies he belongs to. If he doesn’t win the primary, then one has to choose someone in the run-off to vote for…

      Personally I think that this USA system sucks. The other system which gives power to parties also sucks if there is no political party with whom you agree 90%+. So in the end I think that the real way to have real democracy is direct democracy, like Switzerland, with every major decision decided in a plesbicite.

  5. The real problem is that the comfort of modernity incentivizes the abandonment of traditional morality. People decide the do not need children or a husband to help support them, but still want the sex and maybe only one of those things. And there is no intrinsic economic prohibition on behaving that way.

  6. Great post, the human interest part reminding me of what a trial lawyer frined of mine said when I asked him how he got interested in trial work: “Every night when my Dad came home we would have a trial, he was the judge, Mom was the prosecution and I was the defendant, represented pro se.”


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