Friday, September 16, 2005

Moral Hazard and Rebuilding

Even before Katrina hit, the amount of economic damage caused by hurricanes every year was growing. But hurricanes have been more damaging not primarily because hurricanes are becoming more powerful, but because more and more building takes place in the zone affected by hurricanes.

Which brings up the concept of "moral hazard." In insurance, moral hazard signifies the incentive that the insured can have to behave in a risky way, or to commit fraud. Moral hazard is the reason that an insurance company won’t sell a $200,000 policy on a house that’s worth $100,000. The temptation to commit arson would be too strong. Similarly, in setting disability insurance or unemployment insurance levels, we have to balance the moral imperative to supply a decent standard of living to the unfortunate with the moral hazard generated by making it appealing to be unemployed or disabled.

People are encouraged to live in hurricane-plagued areas by a variety of government policies. The federal government subsidizes flood insurance. State insurance commissions prohibit higher premiums for property in coastal areas. And governments pay to help rebuild hurricane-ravaged areas.

President Bush has outlined an approach to rebuilding after Katrina that seems to be based on encouraging continued renewed population growth along the Gulf Coast by providing tax relief for businesses in hurricane-affected areas, and by using federal money to rebuild infrastructure. The President’s speech also mentions, sensibly, improved building codes. Press coverage has focused on whether the President can regain political strength by a show of generosity, whether conservatives in Congress will support the big spending that the President’s plan requires, and whether or not it is responsible to embark on a huge new program along with a war, while preserving tax cuts for the rich.

Sensible questions all. But what about whether it’s a good policy to encourage building in places that are so vulnerable? No one seems to be asking that question of the President’s plan.

So what’s the alternative? Citizen Cain certainly doesn’t want to be heartless toward the victims of hurricanes. But he also doesn't want to encourage people to build homes that will be destroyed by hurricanes. So here is the Citizen Cain plan:
  • assistance with paying for housing and finding work for people displaced by the hurricane. Receiving assistance should not be contingent on staying in the hurricane-affected areas, but should be equally available to those who choose to move out of the hurricane zone;
  • revision of state and federal insurance policies on the principle that people who choose to live in dangerous areas should bear more of the financial risk of doing so. New Orleans, however, would be an exception to this rule;
  • massive federal assistance for rebuilding infrastructure in New Orleans, and for strengthening levees, wetlands, and sea barriers that protect the city, but much more limited federal assistance for rebuilding other hurricane-damaged areas.

And why does the Citizen Cain plan favor New Orleans at the expense of other areas? Several reasons:

  • a port at the mouth of the Mississippi River is vital to American commerce;
  • New Orleans has been made more vulnerable by federal policies that have raised the level of the Mississippi, lowered the level of the land (through oil drilling) destroyed wetlands and barrier islands, and created navigation channels that funnel storm surges right to the city;
  • we can’t protect everything. New Orleans is the most valuable piece of property in the hurricane-ravaged area, economically, culturally and gastronomically. So let’s protect it with all the levels and dikes that are required, spend what it takes to make it a vital place once again, and adopt a policy for the rest of the Gulf Coast that respects the concept of moral hazard.