Insurance, Market Failures, and Bailouts

Let's cover a few issues today. As we sit in the midst of the devastation wrought by Ike on his trek north, a lot of people seem to be confused about the proper role of government. First off, the government is not the insurance provider of last resort. Part of the reason there is so much crap in Galveston to lose is because people forgot the nature of insurance. Insurance is to reduce the financial impact of extraordinary events that are unlikely to occur. A hurricane along the Gulf Coast of Texas is not an unlikely event. Statistically speaking, over a long enough term, it's a certainty. Galveston will get hit by another hurricane. It may be in 5 years, it may be in 50. But it's gonna happen. The only question in anybody's mind should be when, not if. Given this fact, insurance for properties on Galveston Island should be ruinously expensive. Any risk assessment guy worth his paycheck is going figure this out, and set premiums accordingly.

Let me digress for a brief moment. I have a large, fast motorcycle. I can afford to insure said motorcycle because I am old and married. A friend of mine, who is much younger and single, bought himself a similar motorcycle. He was unable to get full coverage insurance for a yearly premium that was less than the purchase price of the motorcycle. After many repeated and frustrating phone calls, an insurance agent took pity on him and explained to him the ugly truth. From a statistical perspective, a single male under the age of 25 is going to total a liter-class sportbike within the first year of ownership. So the premium on the bike is going to be what the insurance company figures they'll pay out, plus some extra so they make a profit. Ergo, he was going to have to pay more than the purchase price to insure the bike.

Returning to our property on Galveston Island, some bright soul can figure the odds of a catastrophic hurricane hitting the island in any given year. I'm going to call it as one every 25 years, based on Alicia and Ike. So the insurance company knows that whatever structure you have stands roughly a 4% chance every year that it will be a complete loss. Your premiums for this are going to be set accordingly, right? Wrong. The rates are not set based on risk, they are set by legislators on the federal and state level. Flood insurance is federal, and the wind insurance pool for Texas is state. The premium rates for both of these programs are insufficient to cover the expected payout losses in the event of a large catastrophic event. So who ends up picking up the tab for some asshat who wanted a half-million dollar house on a coastal barrier island? Why, all of us, of course! Don't you feel glad that you're helping subsidize people's poor life choices yet again?

Now many on the left would be quick to point out that a lot of the people whose livelihoods and homes have been destroyed by Ike are not multi-millionaires with expensive vacation homes. They are, in fact, normal working-class folks just trying to get by. This is true. This also doesn't change the cold, hard facts. Building a structure you want to keep on a coastal barrier island in a region known for hurricanes is a dumb fucking idea. For that matter, building houses any number of places subject to earthquakes, avalanches, mudslides, typhoons, or any other regularly occurring natural disaster falls under the heading of fucking stupid. Actually, it's not necessarily stupid. Building in full foreknowledge of the possible consequences and managing your risk so that you are not rendered penniless and destitute should the easily foreseeable disaster occur is not stupid. Anybody who has done so, please raise your hand. Hmm. I'm not seeing a lot of hands raised. Expecting everyone else to pay for the consequences of your risky behavior is also not stupid. Greedy, selfish, and immoral would be the words I would use to describe that behavior. There are some hard truths here for many, many coastal residents. It's nice that you wanna live on the coast and smell the salt breezes. I wanna live in Antarctica in my Fortress of Solitude
at the Mountains of Madness. When all you shore-dwelling types agree to pony up for my desired lifestyle choice, I'll think about helping you. In the meantime, accept the risk of living where you do and quit expecting the rest of us to subsidize your choices and pay to rebuild your house when the inevitable happens.

Some people would also call the insurance prices that would prevail in the absence of the government rigging the market (poorly, I might add) a market failure. The failure of the market to provide something you think should be available at a price you are willing to pay is not now, nor will it ever be, a market failure. If we accept the common definition of a market failure as a situation where the market does not provide the most efficient resources, absurdly expensive insurance for the coast is the furthest thing from a market failure. Let's have a simple thought experiment about which is more efficient in terms of resource utilization. Option A: pricing insurance realistically and not building much on the coast. Option B: underpricing insurance and having 25 billion dollars worth of shit destroyed? Here's a hint for the slower members of class. Google "Bastiat broken window fallacy" and get back to me.

Finally, who on earth decided it was a good idea to bail out the dumbasses on Wall Street who keep running their businesses into the ground? Do none of you ignuts understand the concept of a moral hazard and the iron rule that if you subsidize a behavior you get more of the behavior? Yay! More risk taking from investment banks, because what the hell, if they fuck it up the Feds'll pick up the tab. I'm glad I'm going back to work tomorrow so I don't have to pay as much attention to all of this. What kind of fucked system are we trying to make where reward is private and the risk is passed on to the public?