No. 63 · Risk · Economics
Moral Hazard
People take bigger risks when someone else will pay if things go wrong.
In the Almanac
“The savings and loan crisis”, 1980s · “AIG”, 2008
Both stories in full, three ways to use it and where it misleads.
Get the AlmanacListen · Watch
Questions
What is Moral Hazard?
Moral Hazard is the tendency to take on more risk when you are shielded from the consequences. Insurance, guarantees and bailouts are useful, but they can quietly change behavior when the decision maker keeps the upside and someone else absorbs the downside.
How do you use Moral Hazard?
Whenever you design incentives, offer help or accept a guarantee, ask who pays if it fails. Keep authority and responsibility together, and make sure risk-takers keep some skin in the game.
When does Moral Hazard matter?
Moral Hazard is one of the 32 mental models for risk, the situations where you ask: What could go wrong, and what will I do if it does? Within that, it belongs to “Protecting yourself”, alongside Antifragility, De-Risking and Margin of Safety.
What is an example of Moral Hazard?
Two stories show it at work: The savings and loan crisis (1980s) and AIG (2008). Both are told in full in The Mental Models Daily Almanac, which has two stories for each of its 365 models.
Which mental models are related to Moral Hazard?
Principal-Agent Problem, Adverse Selection and Perverse Incentives. Moral Hazard itself comes from economics.