Moral hazard is created by a law or situation that incentivizes someone to take on risk with the assumption that someone else will pay the expected cost of that risk. It doesn’t remove the downside, but defers it to someone else. Without fail, this encourages the people who won’t be negatively effected to act irresponsibly. In removing concern for the consequences of a risky behavior, a moral hazard entices someone to act without regard to the consequences of their actions.
Examples can be found in large and small groups, from the doctor defrauding Medicare and pocketing the taxpayer money (when you steal from everybody you steal from nobody in particular) to the child carelessly making dirty dishes because he knows his mom will clean them.
Although it’s typically used to describe the unintended and undesirable side effects of a rule, some moral hazards can have a net benefit on society. In 1970, for instance, Congress imposed a fifty-dollar cap on consumers’ liability for unauthorized credit card use. This shifted responsibility for secure credit transactions to the credit card companies and in time made the Internet a safer place to go shopping.
Unfortunately, there are many more negative examples of morally hazardous corruption: student loans that encourage well-intentioned students to overpay for degrees they’ll spend the remainder of their youth paying for, and health insurance programs that subsidize treatments for smoking-induced emphysema or organ transplants for heavy drinkers.
Moral Hazard isn’t a ‘thing’ in itself, which confused me for a long time, but quality of a given circumstance. It’s always prudent to consider the moral hazard of any situation you orchestrate, whether it be in the rules you come up with or the way you treat other people.
“Moral hazard is when somebody takes your money and is not responsible for it.”
–Gordon Gekko, Wall Street: Money Never Sleeps