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Moral Hazard on your AM Dial:

I happened yesterday to have a long drive up the East Coast, during which I spent a fair bit of time listening to AM radio -- mostly sports talk, some of the news or other talk stations. It's an interesting take on things, the AM radio take. In about an hour and half of the Mike Francesa show on WFAN, the leading sports talk station in and around NYC, (during which, incidentally, I heard a wonderful half-hour Francesa monologue on the recent death of former Yankee Tom Tresh - anyone (like me) who grew up in the 50s and 60s in NYC and cared about baseball (and who didn't care about baseball in NYC in the 50s and 60s?) will surely have lots of memories of Tom Tresh) -- I must have heard advertisements for four or five different debt consolidation companies, all promising me that they could consolidate all of my credit card debt into a single payment, and that I would be able to make some of the debt disappear entirely. I suspect that boom days are ahead for these companies, and they're madly rushing to fill the anticipated demand. Sounds like a damned good deal! I'd love to pay 50 or 60 cents on the dollar on my credit card bill -- who wouldn't?

It's a strange business, debt consolidation. I happen to know a fair bit about it - not, thankfully, because I've had problems with credit card debt in the past, but because when I was practicing law 20 years or so ago, one of my biggest clients was one of the US's largest debt collection firms. The basic idea is pretty straightforward: if your bank or credit card company, to whom you owe $10K or $15K or whatever, believes that you are under water and unable to pay it all off, the rational thing for them to do is to sell your debt to a 3d party in exchange for some percentage of face value (and I can tell you that the negotiations over those percentages -- the bank wants them as high as possible, the consolidator as low as possible -- are ferocious).

The problem, of course, is that if consumers know that will happen, ex ante, they will be more profligate in their spending. If they know they'll be able to write off 50% of their credit card debt, all of a sudden the world is a big "EVERYTHING HALF PRICE!!" sale. Everything - that nice flat screen TV, those boots, that iPhone, a new refrigerator, etc. -- is a lot cheaper and more attractive, you don't have to pay my credit card bill in full.

Debt consolidators will only take you as a client if you're really a mess, financially, because their job is to convince the banks that you're never going to pay them back, and that your debts are damn near worthless to the banks. [That's why the debt collection firms aren't really interested in talking to you unless you have, say, $15,000 or $20,000 of debt].

It's just one of the small oddities of our financial system -- a nice little reward you can get for being monumentally imprudent in your spending. It's not, of course, why we're in the mess we're in -- but it's not completely unrelated to it, either.

A Law Dawg:
These guys are all over those stations of Satellite Radio that play commercials (such as simulcasts of TV broadcasts, which play different commercials from their TV counterparts).
10.17.2008 2:21pm
Adam J:
It's not that huge a reward for the shmucks who get themselves in that situation, since the majority of the debt is probably late payment penalties and interest charges (the interest rate on credit cards is incredibly high for those with poor credit ratings- easily over 20%).
10.17.2008 2:27pm
JB:
It seems to me that this would kill one's credit rating and thus tend to make the financial-OKness scale J-shaped. On the right, you have the people who are very OK, who have no significant debt, manage their money well, and thus have no need of this service at all. On the left, you have people who are an utter mess and need this. In the middle, you have people who would otherwise work hard to get to the right side, but because of this type of service find it easier to backslide to the left.

It's like the areas of Miami where no one has car insurance so they won't have to pay for crashes. That's a great way to save money--unless you ever want to have any property at all. If you're planning to live your entire life judgment proof, things like this are a strong incentive to do so.
10.17.2008 2:29pm
JosephSlater (mail):
Re Tom Tresh:

I grew up in the small town of Alma, Michigan. When I was a kid, I was a Tigers fan (and Tresh spent some time with the Tigers). Tresh actually owned and operated a Kentucky Fried Chicken store in town. When my family would eat there (usually when my mom was out of town), Tresh was happy to show me a nifty collection of baseball stuff, which he kept in the store. I was just a kid, but he struck me as a nice guy, and obviously the good memory has stayed with me. So RIP Tom.
10.17.2008 2:49pm
DebtIsRising (mail):
Boy, is that tempting these days. Imagine a situation where you invest several years in a degree (which got more expensive as children arrived), then weren't able to use it. Then, you invested what you had left in a home-based business, did really well for 3 months, then had a health issue come and knock you completely out of that game.

It's felt like financial moving goal-posts. "Just get to X, and you'll be able to start paying things off - oh, wait, now get to Y. Oh, no, now it's somewhere past Z."

But then, it seems like at least a good many of such companies are really scams (the ones that charge you up front based on how much they say they will save you, for instance). Where are the companies like the ones you're talking about? I'm afraid I'll be needing one soon.
10.17.2008 2:57pm
Forgotten Password (mail):
David;

That is exactly the same message sent by the government bailout of Wall Street -- If you're going to screw up, make sure you do it with nine zeros after it so you are de facto "Too Big To Fail", and are entitled to a bailout from the ultimate bagholder, the taxpayer. The term "moral hazzard" seems ubiquitous these days, but if there's a more accurate term I don't know what it is.

How ironic that the housing market probem that started because everyone in the buying chain (the home-renter; Realt(wh)or(e); mortgage broker; IB; bond investor) was spending other peoples money is presented with a $700B (and counting) 'solution' by the pinnacle of those spending other people's money (Congress).
10.17.2008 3:01pm
SDProsecutor:
While I don't disagree that the AM dial has some interesting (and esoteric) offerings, if you're going to be making these drives with any frequency, satellite radio is well worth the investment. I have been bringing my portable (XM Roady) into the office with me and playing it through the computer speakers for a few years, which justifies the investment even when I'm not doing a lot of driving.
10.17.2008 3:05pm
Calculated Risk:

a nice little reward you can get for being monumentally imprudent in your spending


That is like saying that bankruptcy is a nice little "reward" that you can get for being monumentally imprudent in your spending. Hey, its even a better deal! You pay zero cents on the dollar!

The problem, of course, is that you are going to massively ruin your credit. Maybe people would be better off without this "reward" and just stick to paying their bills?
10.17.2008 3:35pm
FWB (mail):
This is not some simple oddity. This is greed, dishonor, theft by fiat. First, NO ONE should be allowed to "wipe" out debt this way because the debt is not wiped out it is transferred to the shoulders of those who pay their bills. First, everything of value should be taken from these individuals and sold to pay the debt, even if it means leaving them destitute and homeless, children and all. Next, send them to the homeless shelter, turn around and walk away. People who act foolishly, run up debts, and in turn screw the world through these immoral, unethical methods deserve every penalty and punishment they receive.
10.17.2008 3:40pm
A Law Dawg:
This is not some simple oddity. This is greed, dishonor, theft by fiat. First, NO ONE should be allowed to "wipe" out debt this way because the debt is not wiped out it is transferred to the shoulders of those who pay their bills. First, everything of value should be taken from these individuals and sold to pay the debt, even if it means leaving them destitute and homeless, children and all. Next, send them to the homeless shelter, turn around and walk away. People who act foolishly, run up debts, and in turn screw the world through these immoral, unethical methods deserve every penalty and punishment they receive.


Are you aware that the creditors agree to this by choice?
10.17.2008 3:46pm
Brad Ford:
"a nice little reward you can get for being monumentally imprudent in your spending"

What about the various mortgage bailout plans?

Let's say two people buy $400,000 homes next door to each other in 2005. Bob puts 20% down. Furthermore, Bob's income is sufficient to support a $320,000 loan. Tim puts down 0% on an interest only loan. Although he can afford the "teaser" rate, he cannot afford to pay any money towards principal. After the subprime debacle and the foreclosure crisis, both homes are now worth $250,000.

Under the various mortgage bailout plans, Tim will qualify for all kinds of "programs" to "keep him in his home." In all likelihood, the federdal/state government will subsidize a transaction resulting in Tim owing $220,000 on his "new" mortgage fixed for 30 years.

Although Bob is underwater on his loan, he cannot get assistance from the government or the banks because he can continue to make the minimum payment. Until he loses his job or the market price in homes rebounds (good luck with that), he is stuck in his home and unable to refinance.
10.17.2008 3:46pm
Malthus:
Y'all who are thumping insurance have it all bassackwards. Folks who eschew insurance of all kinds, beginning in their youth, save tens of thousands of dollars per year. Putting the amount of the premiums in the mattress, or even better, in stocks and bonds, they soon get to a point were they don't need anybody's "credit."

Indeed, my spreadsheet shows that, if a person doing that could avoid SS, Medicare and other insurance premiums starting at age 20 (the Amish do!), he will have about $7,000,000 in the bank at age 65 after having paid for all his losses from savings and from non-recourse borrowing against assets. Of course, he would then have to face retirement with only some $490,000 annual income (from dividends and interest alone) instead of the $18,000 from Social Security, and, if he died early, would have only $490,000 to leave to his heirs instead of the SS death benefit of between $0 and $255.

Insurance is nothing but the religion of risk-averse fools.
10.17.2008 3:56pm
pete (mail) (www):

Are you aware that the creditors agree to this by choice?


And that this is all unsecured debt so the creditors knew what they were getting into. One reason credit card interest rates are in the 10-20% range now (while car/house rates hover more around 6-7%) is that bad credit is about all they can hold over the person.

I do not like dead beats either, but the credit card companies know the risk they are taking when they hand these cards out.
10.17.2008 3:59pm
A Law Dawg:
Insurance is nothing but the religion of risk-averse fools.


Until you get plowed into by a risk-taking teenager.
10.17.2008 4:00pm
FantasiaWHT:

Insurance is nothing but the religion of risk-averse fools.

Until you get plowed into by a risk-taking teenager.


But the point is you would have enough to pay your medical bills yourself if you weren't paying insurance (and all the other risk-avoiding contrivances.

And, by the way, exactly how is having insurance yourself going to help when you aren't the at-fault? Your $1k or $5k of medpay is about it. Unless the other driver is also uninsured, but then we're back anyway at having enough money yourself to pay your bills.

The problem with that argument, however, is that the more money you save up, the bigger reason you have to actually get insurance to protect your assets.

Sadly, if you have no insurance, you're less likely to be sued, especially if you don't have any real assets.
10.17.2008 4:20pm
LarryA (mail) (www):
In related news San Antonio's biggest "Your credit rating doesn't matter" car dealer just went belly up. (video)
10.17.2008 4:44pm
A Law Dawg:
And, by the way, exactly how is having insurance yourself going to help when you aren't the at-fault?


Is litigation to determine fault and damages free for those who don't pay for insurance?
10.17.2008 4:46pm
Alan P (mail):
2 points.

Malthus

Saving tens of thousands in insurance premiums a year.

Really. All of my insurance premiums including car homeowners and business insurance such as Workers Comp amount to about four thousand a year. Medical insurance is the most expensive. I suppose if you can guarantee me that I will never get sick, just putting that money away would be a better deal.

As far as the irony of the profligate being rewarded when they can't pay their debts, I learned that lesson early on. I worked for the Federal Government collecting debts owed to the Government for VA loan defaults, student loan defaults, and contract defaults. When deciding how hard or far to purse a claim, we would obtain credit reports on the debtors. The reality was the harder a person worked and saved to have something put away, the more likely we were to file suit. If they had nothing, we simply dropped it. Fair. Of course not. Reality. Yes
10.17.2008 4:47pm
Dan Weber (www):
Saving tens of thousands in insurance premiums a year.

That got me too, but if you read on he's counting FICA payments as insurance.
10.17.2008 4:58pm
John M. Perkins (mail):
My first live MLB game, July 15, 1963, Yankees at A's. I'm 7, and bring my Yankees and A's baseball cards. My big sister, age 12, decides to root for the evil visitors. Why? Because Tom Tresh was "cute." Yecch!

Good news is that Kansas City won the game, both teams scoring 1 in the 9th, 3 in the 11th, with the A's winning 11-10 in 12 innings on a two out bases loaded walk to the best 2B in the game, Jerry Lumpe.

And the other 2B?
The evil cute Tresh went 0 for 3, scored twice with 3 walks, a stolen base, and semi-happily, an HBP.
10.17.2008 4:59pm
whit:
This is a textbook example of the concept of perverse incentives.

Reward people for bad behavior and you make bad behavior more commonplace, more accepted, and raise the costs that the people who DON'T engage in bad behavior must pay to keep the system afloat.
10.17.2008 5:40pm
Malthus:
Law Dawg is a good example of the problem:

"Until you get plowed into by a risk-taking teenager."

-- A scientist (statistician), as opposed to the typical lawyer, is capable of figuring out problems of evidentiary bias. What he would do is this:

First, take a sample that might be a day in the life of the folks of Peoria. Determine how much they paid in insurance premiums of every kind (yes: FICA+health+auto+flood, etc) and then simply subtract how much they had received in insurance awards for damages. The positive result will astound you!

But wait! Then consider the moral hazards caused and covered by insurance: careless driving, hypochondria, staging of accidents, cracked windshields, fraud, etc.

But wait! Then consider the transfer payments from the Black man to the White woman implicit in FICA, from Youth to Oldster in health insurance, from those who hardly drive to those who drive a lot in car insurance, etc.

"Is litigation to determine fault and damages free for those who don't pay for insurance?"

-- No, but that's why Al Gore invented ambulance-chasing lawyers!
10.17.2008 6:17pm
David M. Nieporent (www):
John: I assume your family left her at the game and made her find her own way home?


As Adam J points out in the second comment, you're not getting anything at half price, because you don't get to the debt consolidation point until you've racked up huge fees and interest. So, while you are getting something you couldn't have afforded at the time, you're not getting a great deal and the moral hazard doesn't really exist.
10.17.2008 6:18pm
A Law Dawg:
A scientist (statistician), as opposed to the typical lawyer, is capable of figuring out problems of evidentiary bias. What he would do is this:
First, take a sample that might be a day in the life of the folks of Peoria. Determine how much they paid in insurance premiums of every kind (yes: FICA+health+auto+flood, etc) and then simply subtract how much they had received in insurance awards for damages. The positive result will astound you!


Your contention, o wise statistician, is that the ability to bear those losses are equal between the good people of Peoria?
10.17.2008 7:06pm
neurodoc:
Medical insurance is the most expensive. I suppose if you can guarantee me that I will never get sick, just putting that money away would be a better deal.
Right, if you can be guaranteed that you will never become sick and incur significant medical bills, then you could save a substantial amount of money. But no one can guarantee that you or they will not become sick and incur significant medical bills, so there is the alternative type of guarantee you can get, which is that if you do become sick, you will not be solely responsible for their payment. That alternative type of guarantee is commonly referred to as health insurance.

The notion that it is a good idea to forego health insurance and save what would have been spent on premium payments is a foolish one. It fails to take into account the basic rationale for insuring oneself against loss, which is that unless one is financially very well off and secure, it is better to pay more in premiums than their expected loss, because a big hit loss might prove so devastating that they could not recover financially. Also, it fails to recognize that the cost of health insurance is greatly reduced for most by a huge subsidy from Uncle Sam, who allows health insurance to be treated as a business expense, and thus be a tax-free benefit for employees. And, many insurance companies (e.g., Blue Cross/Blue Shield) get very substantial discounts from health care providers, especially hospitals, that self-paying individuals don't get, meaning they pay substantially more for the same services.

Also, many forms of insurance (e.g., automobile and homeowners) provide a defense if the insured is sued. Those insurance companies fight doggedly to avoid paying plaintiffs, and they are charged less for legal services than most individuals who have to defend themsselves.
10.17.2008 9:45pm
JaredS:
Malthus:

Word.

Also, look at those idiots who invest in index funds with their management fees or waste tons of money on commissions assembling a diversified portfolio of stocks. When I want to invest in stock, I simply decide what I'd want my portfolio would look like, make a weighted random selection of a single company from that portfolio, and invest all my money in its stock, paying a single commission.

It's obvious that if one large population follows my strategy, and another invests in the same average portfolio but each person diversifies, the people in my group will have a better average return because they won't be wasting money on the aforementioned overhead of diversified stock ownership.

It's good being a risk-neutral agent!
10.17.2008 11:51pm
theobromophile (www):
neurodoc: good points, but it seems as if catastrophic health insurance would be a (reasonable) compromise. Rather than paying thousands per year, you would pay hundreds; the only risk you take is up to a certain amount in medical bills. That which would wipe out your savings is covered by the plan.
10.18.2008 4:28pm
Richard Souther:
FantasiaWHT: "And, by the way, exactly how is having insurance yourself going to help when you aren't the at-fault? Your $1k or $5k of medpay is about it. Unless the other driver is also uninsured, but then we're back anyway at having enough money yourself to pay your bills."

As an insurance defense attorney, I can assure you that your insurance provides a greater benefit than just medpay or uninsured motorist (UM) coverage. It also provides underinsured motorist (UIM) coverage. If the other driver only has the minimum legally required coverage, which can be as low as $20,000, and your medical bills exceed his coverage, your own insurance coverage, if it is high enough, will pay the difference between the other driver's coverage and your coverage. This way, if your compensatory damages settlement, or award, exceeds the other driver's insurance coverage, your insurance will make up the difference and take over the job of trying to collect from the other driver.

This is the biggest argument for avoiding being underinsured with respect to auto insurance: you just do not know when another driver will not be paying attention, plow into you, leave you will high medical bills, and not possess enough insurance to cover your medical bills. For an indicator of the frequency of this occurring, just scan your local paper on Saturday or Sunday for the reports of auto accidents involving drunk drivers.
10.18.2008 6:58pm
Jmaie (mail):
if a person doing that could avoid SS, Medicare and ...

Oh wise one, please inform this lowly salaryman how to accomplish same?
10.19.2008 1:18am
ReaderY:
Creditors need to use some discretion in whom they lend to. They make are not blind, stupid, or babies. They are supposed to make prudent and informed decisions. Bankruptcy law providing for giving debtors a fresh start (albeit without a fresh reputation) is part of the U.S. constitution and a part of our legal tradition that I see no reason to give up. Lenders who lent $5000 to people who had already borrowed $15,000 should learn to be more prudent and careful with their money in the future. If lenders lent based on the expected future value of people's homes rather than people's income, debts, and cash flows, they did this voluntarily and they took a risk by doing it. If they didn't account for the risk adequately, they have only themselves to blame.

The problem with our tendency to try and find a way to blame others when bad things happen is that we can never learn. Both lenders and borrowers messed up and they both deserve to take some responsibility.
10.19.2008 5:48pm
Deoxy (mail):
Malthus,

Please pursue this plan yourself.

You can then write to us from prison (for not paying a good chunk of your taxes) and tell us how it's going.

Really, that's where most of the money you are referring to goes.

Also, the entire point of insurance is "catastrophic loss" - anything you use all the time is simply paying someone to touch your money before it gets where you need it to go.

Unfortunately, incentives created by congress cause the prices of most things medical to be outrageously priced, and thus, you need some kind of plan that helps you bring those prices back to normal.

In short, much of this mess is created by the government. I'm shocked.
10.20.2008 1:45pm