One domestic and one foreign policy issue have dominated public concern for the last week or so. The domestic issue is the mortgage crisis created by the issuance of so-called sub-prime loans—generally large loans to people financially unqualified for and unable to meet the long-term requirements of those loans—on housing. The policy question is what to do about the ensuing rush of home foreclosures that threatens lending institutions and homeowners about to be dispossessed. The foreign policy issue is the renewed outbreak of sectarian violence in Iraq, which threatens to upset the fragile tranquility contributed to the surge of American troops in the country.
Do these two events have anything in common? On the surface, they do not, but it may be possible to create a conceptual link between them. That link is the notion of moral hazard.
The concept of moral hazard is normally associated with economics, and refers, in a general way, to the problem of what to do when economic institutions act foolishly or imprudently in ways that threatens the economic well-being of themselves and others, such as investors. The problem is what to do when this occurs, and one common way to dissipate the effect of these bad economic decisions is in the form of some kind of bailout that reimburses those who have lost as a result of unwise actions. The rationale for subsidy is to avoid both grievous losses to innocent victims (investors who did not know what was being done, for instance) and the economy more generally. The moral hazard arises because the act of subsidizing those who have committed errors in effect rewards them for their bad behavior and sends a message that reckless behavior not only may not be punished in the future, but may be rewarded. Does one send that message, or let the economy and individuals suffer? That is the dilemma that faced the political system at the time of the saving and loan (S&L) crisis of the middle 1980s, at the time of the Asian financial crisis of 1998, and again today.
The same logic can be applied to reacting to the upsurge in inter-Iraqi violence this past week. The fighting has unglued one fundamental part of the reduced violence equation that has underpinned claims the surge is “succeeding” in reducing violence. The three argued pillars of reduced violence have been the introduction of additional American forces (the surge), the defection of Sunnis from support to opposition to Al Qaeda in Iraq (thereby allying them with the Americans—at least for the time being), and the ceasefire by the Mahdi Army of Sheikh Muktada al-Sadr. Al-Sadr’s forces have broken their part of the arrangement, engaging in battle with Iraqi armed forces (which are, to many observers, simply extensions of other Shiite factions in the country).
What is the United States to do? The first reaction has been support for the so-called “pause” in reductions of American forces as force numbers are returned to pre-surge levels. While the advertised idea is to see what happens after a modest troop reduction in terms of violence, the effect is also to provide something of a buffer against more inter- and intra-communal violence by keeping as many Americans as possible in a position to suppress that violence.
But does that approach not amount to another form of moral hazard? For Iraqis, the effect of more Americans staying is to suppress levels of violence by putting the screws to the warring factions. But is this not rewarding the Iraqis for their bad behavior? If it is, that is the essence of moral hazard.
Why would the U.S. gravitate toward this form of moral hazard? For the same reason that the U.S. government will end up pumping money into the housing market to protect imprudent borrowers and predatory lenders from their bad behavior: it is politically more acceptable to commit the ethereal, hypothetical sin of moral hazard than to kick people out of their homes or to take punitive actions that may deepen the recession. Similarly, the “pause” may reward bad Iraqi behavior, but it also avoids an imminent collapse of the surge-argued peace and allows proponents—whether they are outgoing presidents who do not want the legacy of having “lost” Iraq or aspiring presidential candidates wedded to the cause—to avoid embarrassing consequences.
Is moral hazard in war any more palatable than it is in peace?