Externalities in a YoYo Society

By Dave Anderson:

The dominant trend in risk management over my entire life time has been one of risk transferrance from the large, impersonal and statistically capable organizations and entities to the individual.  We have seen the death of defined benefit pensions for almost anyone in my generation.  The Republican Party has long advocated that the great problem in health care is not that people have too little access to insurance and risk-spreading, but too much insurance.  Furthermore John McCain argued in 2008 that there is no need for individual consumer protections in the individual policy market.  Social Security is under attack from the bi-partisan Pain Caucus who can ride out any systemic event that would destroy most peoples' abilities to retire. 

Risk has been shifted from entities that can afford to time smooth to individuals that can not.  And this has been done in the quest for "economic efficiency" that looks pretty in pure rational choice theories but runs up against Simon's bounded rationality and empirical reality very early on. 

We live in a society where large businesses are told that their only consideration should be profit and returns to stock-holders.  Under this dictum, it is appropriate for the US to court massive public externalities if GM was to go bankrupt and destroy the auto-supplier network in the Midwest if it boosted the resale value of its parts.  It was appropriate for US Steel to destroy the heavy industrial basis of the Mon Valley.  It was appropriate for Goldman Sachs, JP Morgan and other investment bankers to swindle untold billions selling complex interest rate swaps to local municipal authorities.  All of those actions either made, or would have made a short term profit, and under the dominant ideology, any other consideration or intervention would be wrong.  

So why does this cold-blooded calculation of net internalized profit seeking not pertain to individuals?   Why should individuals get kicked in the gut if dodging a punch produces far less pain for them while spreading pain to their neighbors?  It goes against the official business ideology and legal framework of the past generation for a large business to act altruistically in the pursuit of non-internalized social benefits. 

The New York Times examines the externalization of foreclosure costs by individuals who are considering strategic default:

So some [homeowners] of them are making a calculated decision
to hang onto their money and let their homes go.

Is this irresponsible?Businesses � in particular Wall Street banks � make such calculations routinely. Morgan Stanley
recently decided to stop making payments on five San Francisco office
buildings. A Morgan Stanley fund purchased the buildings at the height
of the boom, and their value has plunged. Nobody has said Morgan
Stanley is immoral....

Mortgage holders do sign a promissory note, which is a promise to pay.
But the contract explicitly details the penalty for nonpayment �
surrender of the property. The borrower isn�t escaping the
consequences; he is suffering them....

the government...should encourage borrowers to default when
it�s in their economic interest. This would correct a prevailing
imbalance... More important, it might
get the system unstuck. If lenders feared an avalanche of strategic
defaults, they would have an incentive to renegotiate loan terms.

In non-recourse states, there are four ways for an individual to satisfy a mortgage contract.  The first is to make the specified number of payments over the course of time.  The second is to make a large single payment that is equal to the capital value of the note (such as in a refinancing).  The third is to give the mortgage owner(s) the keys while walking away.  The final solution is to reach a mutual re-arrangement of the original contract.  That is it, and any of those options are valid options for businesses.

In a society where the individual is on their own and the pursuit of profit is the only value that is held by every other actor, individuals should also seek to internalize their profits, even if those profits come at net social costs.  Strategic default is rational under the current rule and ideology set.

The societal-wide response in the short term should be a governmental response as government is the entity that is best able to solve collective action problems where individual pursuit of private profit inflicts significant costs on everyone else.  Ian Welsh a few weeks ago outlined a reasonably government program that would address the foreclosure externality problem:

What the government should do instead is set up a Trust to buy
mortgages at a discount, then reset them to 20, 30 or 50 year fixed
mortgages with a reduced face amount. If the house is later sold, half
of the increase goes to the government, so that taxpayers make a
profit. The mortgage cannot be paid off before the end of its term so
that financial scavengers cannot come around and, as they did over the
last ten years, say �get rid of that mortgage, and take ours. It�s
better. Honest!�, because we know that when they say better, they don�t
mean better for the mortgage holder.

Society wide collective action responses would require an effective and activist government, and unfortunately, we don't have that or the will to make our government into that.  So individuals who are stuck will, should rationally, seek to save their own hides by acting like businesses, as we, as individuals, have been told and conditioned to act over the past generation, and be ruthless with contracts that no longer make any sense, even if that ruthlessness dumps costs on our neighbors and municipalities.