All about ideas…

A History Lesson: The Role of Social Insurance and Gov’t as Risk Manager

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Taken from an editorial in The NY Times, the following belongs in that “(slap head) DOH!” category of Why-Didn’t-I-Think-of-That.

The financial markets had prided themselves on their expertise in pricing and managing financial risk prudently. But left on their own, they proved that they could not even manage properly as simple a transaction as a mom-and-pop mortgage loan, let alone fancy derivatives such as the collateralized debt obligations (C.D.O.’s) that were based on sloppily-written mortgage loans and the credit-default swaps (C.D.S.’s) meant to insure the value of these C.D.O.’s, but without adequate reserves to back up that credit insurance.

In the end, like teenagers who hate Mother’s strictures when all is well, but run to Mommy whenever they get in trouble, the swashbuckling oligarchs of the financial sector ran to government for cover, owning up once again to the time-honored mantra of this country’s legendary rugged individualists:

When the going gets tough, the tough run to the government.

Another term for “government risk management,” of course, is “social insurance.” […]

Perhaps the argument is that individuals should make their own financial arrangements in the private market for risk management to protect themselves against the financial risks of illness. But then it can be asked why states in disaster-prone areas — e.g., Florida and other states along the Gulf Coast — should not be required to tax themselves on a regular basis for the purchase of private insurance to cover the cost of their fairly predictable calamities, or to set aside adequate rainy-day funds to meet that cost.

Why is it the American way that I in New Jersey should feel obliged to give financial help to a family whose beach house in Mississippi was blown down by a hurricane, but it is socialist and un-American to help a Mississippi woman struck by breast cancer?

One of the most thoughtful recent books on the topic of government risk-management is “When All Else Fails: Government as the Ultimate Risk Manager” (2004), by David A. Moss, a Harvard Business School professor. The author clearly explains in this book why public risk management has become an essential and very popular form of government intervention in modern societies, including the United States, and even among its more staunchly conservative citizens.

Professor Moss explains that the first application of social insurance in our latitudes actually was aimed not at protecting individuals against financial risk, but at supporting the growth of modern capitalism. Its main instrument to that end was the legal sanction of the principle of limited liability of the owners of corporations.

Prior to this form of social insurance, the owners of a business were legally liable with their personal wealth for damages the business might have inflicted on others. With limited liability, the corporation’s shareholders are liable only up to their equity stake in the company. They can lose at most the value of their investment in the corporation’s stock. Beyond that, someone else in society — often the taxpayer — bears the financial risk for damages attributable to the corporation.

One wonders how many business executives and members of chambers of commerce around the country realize that the limited liability of shareholders is social insurance.


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