Moral Hazard in Mortgages

“The cherished American ideal of self-reliance has a flip side”[1]  Before getting to the implications, or flip side, I want to fill out what informs this ideal. One could add to it the ideological stance that came into its own in 1980 with the election of Ronald Reagan, who declared that government is the problem. This implies that government should be minimized, and otherwise corrected as much as possible. Government is hardly to be viewed as the solution. This is the legacy of the Kennedy assassinations of the 1960s, the Vietnam War, and Watergate as well as Ford’s pathetic “WIN” buttons and Carter’s micromanagement and failure in regard to the hostages in Iran. I was not old enough for the Kennedys’ truncated optimism (and that of Martin Luther King) to resonate; I knew the political (and economic) pessimism of the 1970s and the energizing “fix it” mentality of the early 1980s. Of course, Reagan’s “new federalism” failed, as did his aim to balance the federal budget, and the jury is still out on whether “peace through strength” pushed the USSR off the cliff.

Reagan is perhaps best known to historians and political theorists for having formally shifted the political paradigm’s default to “government is the problem” after at least a decade of political and economic paralysis. Dovetailing with the American ideal of self-reliance, the default on government was still a headwind for Barak Obama as he found he had to capitulate even on a “public option” for health insurance—relying instead on the same private insurers who had been excluding pre-existing conditions and otherwise cancelling policies at the advent of a new illness. In other words, that the health-insurance lobby could still call the shots at the White House suggests the continuance of the headwind running against government. Relatedly, in the 1990s Bill Clinton had to give up on his vision of using government for grand purposes because the American people were “not there.” Clinton found in the presidency instead a plethora of smaller accomplishments, such as adding to local police forces and otherwise acting as the mayor of an empire as if it took a village. He had figured out how to avoid the headwinds.

With this background in mind, we can now get to the matter of the implications of self-reliance and “government is the problem” as regards moral hazard. In economic terms, it refers to “the undue risks that people are apt to take if they don’t have to bear the consequences. In other words, if the money is free, why not spend it on a designer purse?”[2] Because of moral hazard, backed up by the ideal of self-reliance and the default of “government is the problem,” there is significant discomfort with the idea of bailouts and safety nets in American society. The notion that even a small portion of aid even to homeowners who are “under water” (i.e., they own more on their mortgages than their houses are now worth in terms of equity on the market) might find its way to the undeserving (or cheats) “can be enough to scuttle support, or restrict help so drastically that few can use it.” Adding to this sentiment, typically by vested interests, is the sanctity of contract dogma. This means that a mortgage borrower is obligated to pay whatever he or she had agreed to pay regardless of changed circumstances either of the borrower or the housing market.

Bankers “say that generously easing loan terms or reducing mortgages outright would only encourage homeowners who can pay to pretend they can’t. It would also, the bankers say, send a dangerous message: a financial commitment isn’t really a commitment.”[3] Additionally, homeowners “who keep paying their mortgages, even if their homes have lost value, reasonably wonder why neighbors who weren’t as responsible are getting help.”[4] Behind both of these concerns is resentment that someone else might get something too easily (i.e., beyond that which is deserved and what one can get oneself). It is not a very laudable mentality, psychologically and ethically. In other words, it is rather small. Even worse, bankers who themselves received bonuses paid for in part from bailouts were keeping borrowers from also being bailed out. It is as if the financial crisis of 2008 hit only one side of the ledger.

Shaun Donovan, the secretary of the Department of Housing and Urban Development, said that although there is was a “nugget of truth” to the moral hazard argument, “only about 10 or 15 percent of Americans who can still pay their mortgages try to walk away from their debt. Most troubled homeowners, like the Katrina victims, are genuinely hard up.”[5] Accordingly, the bank bailout should have been oriented to them. Had it been, the banks’ balance sheets would not have been toxic and “two birds” would have been “killed” with “one stone.”

The “specter of moral hazard haunts a basic tension in American life: to what extent are people responsible for their own problems? The more trouble you’re in, moral hazard suggests, the less we should help.”[6] This relationship is the inverse of what it should be. That is, moral hazard should not apply as if survival itself were conditional. I am perhaps as innately American as they come, being born and raised in the Midwest, or “heartland of America.” Even so, when I hear politicians or others refer to others’ survival as somehow conditional (typically as based on a work history), I sense that the ideological belief is distinctly American. I revolt at the sheer self-centeredness of the people expressing the view and I reject the validity of the claim itself. For a society in which survival is deemed to be inherently conditional (as defined by people whose survival is not an issue) is no society at all. Put another way, if we all knew in the back of our heads that were we to fall on hard times and not be able to provide for our own shelter and food without taking them from others (i.e., remaining in society), life for all of us would be a little lighter and less existentially anxious. This is not to say that everyone has a right to a t-bone steak once a week or a mansion. The moral hazard argument conflates these with sustenance needs.

If a person is seriously under water, the sheer depth naturally dwarfs any consideration of culpability. If someone is barely breathing or starving, a natural sentiment of sympathy orients others to the question of how the plight may be quickly assuaged. I submit that the bailed out banker actively resisting any assistance for homeowners near foreclosure has a rather unnatural “hardness of heart,” or hardness more generally. To make aid conditional where basic necessities like shelter, food and medical care hang in the balance is to apply moral hazard beyond its ken. This overreach operates at the expense of human rights.

Essentially, applying moral hazard conditionality where survival itself is at issue for others is to presume a godlike position for oneself. In other words, the propensity to judge others’ extent of deservingness is premised on self-idolatrous pride. Given the nature of self-idolatry, it is no surprise that bankers who have benefited themselves (as well as their banks) would apply moral hazard to their counterparties but not to themselves. The conditionality does not apply to those bankers, whose lobby—which Sen. Durbin said owns Congress—makes sure of it. The resulting asymmetry can be interpreted as a reflection of the bias in the “self-reliance” and “government is the problem” default—a game-board that is tilted toward the rich because they can afford to be self-reliant and scoff at government as part of any solution to societal ills.

Ideally, a social contract, and thus a society, should be in balance, with basic human rights being beyond the reach of the inevitable swings in the political-ideological pendulum (i.e., the headwinds). Where the latter are definitive (and exclusive), sustenance needs, being an inherent human right, become valid outside of societal limits. In other words, where moral hazard is applied to basic shelter and food needs, people needing them have the inalienable human right to take them without regard to societal rules bearing on them. Even in political theory, possession of property is salient. Thomas Hobbes refers to the right of self-preservation as going beyond any law. Is extending moral hazard to cover necessities worth making society (and its laws) conditional?

1. Shaila Dewan, “Moral Hazard: A Tempest-Tossed Idea,” The New York Times, February 26, 2012. 
2. Ibid.
3. Ibid.
4. Ibid.
5. Ibid.
6. Ibid.

BP Clips Societal Norms

In Senate testimony on May 11, 2010,  the three companies did their best to point the finger at each other, with the result that neither BP, Transocean or Halliburton would admit, undoubtedly for liability purposes, any contributory role. In the midst of such liability evasion, those of us in the wider society want to get to the bottom of the accident so future such accidents can be prevented. In pointing the finger at the other guy while ignoring one’s own role, the managers of the three companies are added insult to injury.  

The BP executive did not mention that several days before the explosion on the Deepwater Horizon oil rig, BP officials chose, partly for financial reasons, to use a type of casing for the well that the company knew was the riskier of two options, according to a BP document. Specifically, BP managers opted for a “long string” pipe for the well rather than a liner tieback that would have cost $7 million to $10 million but would have added barriers to prevent gas from reaching the surface.  BP managers were not unaware of this risk. The concern with the method BP chose, the document said, was that if the cement around the casing pipe did not seal properly, gases could leak all the way to the wellhead, where only a single seal would serve as a barrier. 

As another instance of cutting corners to save time and money, BP engineers used just six “centralizers,” rather than twenty-one as recommended by Halliburton, to stabilize the well before cementing it. According to an April 16, 2010 email from BP’s well team leader, the problem was that the extra centralizers would have taken ten hours to install. Another official wrote of the decision: “Who cares, it’s done, end of story, will probably be fine.”[1]   BP managers also decided not to take twelve hours to completely circulate the heavy drilling fluid in the well that would have enabled detection and removal of any leaking gas. BP also skipped a test to determine if the cement had properly bonded to the well and rock formations. A petroleum engineer independent of BP told a congressional committee that the decision was “horribly negligent.”[2]

Workers from the rig and company officials said that hours before the explosion, gases were leaking through the cement, which had been set in place by the oil services contractor, Halliburton, which Dick Cheney once ran. But it was not merely the casing and cement that were problematic. On 60 Minutes on May 16, 2010, a worker who was on the rig when the accident happened spoke of a BP manager overruling a Transocean manager to cut corners, such as beginning to drain the pressure fluid from the well before the third “cork” was installed.  The methane was able to reach the rig’s engines because there was insufficient pressure to keep the gas down in the well.  Also, a BP manager had earlier ignored the worker’s warning that there were shreds of rubber coming up in the drilling–the rubber being from the device that was supposed to take pressure readings (e.g., whether there is gas in the well).  Nevertheless, the BP manager who testified before the Senate blamed Transocean and Halliburton managers, and on the morning after the 60 Minutes interview BP’s COO said he was just focused on the clean-up and knew nothing of such “details” even though his specialty was in development and exploration. Both in cutting corners and in ignoring his job description, BP’s COO demonstrates a willful disregard for societal norms wherein society itself is protected and accountability is accepted.  Sadly, this attitude is not uncommon in the business world.

Perhaps as business operations expand in businesses too big to fail, the societal dangers in the attitude are magnified because more damage can result. In other words, it becomes increasingly dangerous to a society to allow such an attitude to exist.  Where societal norms are ignored by business managers, perhaps the societal norm that allows for their authority should be rescinded as well. This is a social contract reading of society, wherein if one side of the norms are broken, the other side is deemed invalid as well.  The problem is that social contracts unravel rather slowly or incrementally, such that a dangerous attitude can be allowed to remain in a position of authority.  It is worth investigating whether violating societal norms is actually detrimental to a company’s bottom line. 

To the extent that a social contract has a certain inertia, it may be that the bottom line can survive long enough to allow the attitude to survive and perhaps even prosper.   These matters are distinct from questions of justification, which lie in the field of business ethics, and from those of whether more government regulation is needed, which lie in the field of business and government. We can define corporate social responsibility as meeting the general expectation in a society that people admit to their wrong-doing or mistakes and make amends.  This is different from the ethical question of whether people should admit to their wrong-doing or mistakes and if so why.  It is also distinct from the question of the proper relationship between business and government.  Business and society involves the relationship of business interest and societal norms.  To treat the latter (or the former, for that matter) as ethical requires ethical justification, which is more than simply aligning business and societal norms.  In other words, a societal norm is not in itself ethically justifying (consider Nazi Germany as a case in point).  With these distinctions in mind, I turn now to the field of business and society.

I contend that the people at BP (and Halliburton) admitting to their role and paying for economic damages incurred by third parties would be more important than BP’s charitable giving, even if some people in the wider society may have let BP off the hook for the accident if the company’s managers had decided to announce a new philanthropical project unrelated to the accident. Working on another society problem does not make up for having not admitted to BP managers' negligence.  Culpability, on other words. cannot be obviated or transferred so easily.

Too often, business managers use the term “responsibility” even as they are evading it for financial reasons. BP initially estimated the daily output of the leaks at between one and fourteen thousand barrels a day; BP picked the low end-point because the amount of fines the company would pay was tied to the volume. That the company managers were misleading the wider society didn’t seem to factor into their financial decision. As a result, the anticipated damage to the Gulf (and the world) was not sufficiently appreciated in the wider society. The convenient use of  the term “responsibility” can be gleemed from the Senate testamony of Lamar McKay of BP.  “As a responsible party under the Oil Pollution Act,” he said, ”we will carry out our responsibilities.” But he quickly added that Transocean “had responsibility for the safety of the drilling operations.”[3]  That is to say, he acknowledged the obligation to be responsible for his mistakes while conveniently ignoring the mistakes made at his company. By pointing the finger at people at another company, McKay was contradicting his own asseveration on being responsible.  It is like he was lying even as he insisted that people shouldn’t lie.

Pointing the finger is childish, even if it is done for financial reasons. Steven L. Newman, president and chief executive of Transocean, did no better that the BP executive when he said that the accident had to have arisen from elements of the work done by other companies. “Were all appropriate tests run on the cement and the casing?” he asked, apparently implicating Halliburton. Tim Probert of Halliburton said in turn that all work on the casing by his company was carried out “as directed by the well owner,” meaning BP.[4]  Suggesting that the men act like adults and take responsibility for what their coworkers had done (or failed to d0), the ranking Republican minority member on the Senate Energy and Natural Resources Committee, Lisa Murkowski of Alaska, told them to stop the finger-pointing. “I would suggest to all three of you that we are all in this together,” she said.[5] Notice that she is pointing to a societal norm, rather than using an ethical rationale. She is essentially asking the executives to step up to societal standards. Unfortunately, there was no sign that the three boys would take responsibility for their actions, as they continued on, still oriented to the other guy.  The cost to society includes a more difficult route to uncovering the cause of the accident and possible accidents to come from BP. The company’s clean-up efforts do not address the cause of the accident; the spending does not go far enough. In other words, BP can’t spend its way out of it, or can it?  Are there societal norms that allow it to suffice?  My question is this: why hasn’t the social contract unravelled that has allowed the managers at BP to continue to hold their jobs (and BP to remain in business)?  Is economic liberty at play here–society saying that there is room in such liberty for a shirking attitude?

1. Ian Urbina, "BP Used Riskier Method to Seal Well Before Blast," The New York Times, May 26, 2010.

2. Neil King, Jr. and Russell Gold, “Congress Says BP Crew Focused on Costs,” The Wall Street Journal,  June 15, 2010, p. A5.

3. Ibid.

4. Ibid.

5. Ibid.

Is Corporate Social Responsibility the Same as Business Ethics?

Corporate Social Responsibility (CSR) is typically thought to be a topic in the field of business ethics. If a company is socially responsible, it is typically presumed to be ethical in being socially responsible. Solidifying this attribution, some scholars of CSR have even sought to explicitly base it on specific ethical principles. However, contrasting a corporate policy with societal norms or specifying how corporations can get in line with them is not to provide an ethical justification.  Even if a societal norm is consistent with an ethical principle, the norm itself is something that is, rather than a justification for what ought to be. To attempt to derive ought from is is known as the naturalistic fallacy. It is like getting what ought to be from a melon ripening in a field. Is does not imply or justify ought.


This paragraph has been incorporated into the introduction in Cases of Unethical Business, which is available in print and as an ebook at Amazon.