Moral Hazard

Today I was fortunate to enjoy what has become an annual ritual: listening to young people from the LA Conservation Corps talk about where they have been (hell, in too many cases) and their hopes for the future. The Corps’ annual Russell Kantor Scholarship Luncheon, and the annual celebration of an independent living program for emancipated foster youth sponsored by United Friends of the Children, are to my mind the best, and most consistently excellent, events of their kind because of the chance to hear stories of redemption directly from young people. Without fail, it is inspirational and very emotional to hear them.¹

With the economic slide accelerating, expect to see a lot of worry among philanthropy watchers about likely declines in giving by individuals and foundations. Those concerns will be very valid. Programs like the LA Conservation Corps will need to weather some tough times, especially if they receive government funding. But the energy we spend focusing on grant dollars in our corner would be better spent attending to the bigger picture of what investment priorities we set as a nation. 

When the financial crisis first received a lot of attention last August, many commentators invoked the concept of “moral hazard” to argue against protecting homeowners from the expected flood of foreclosures. Now that the Fed has injected $30 billion into a workout of Bear Stearns, and put billions more into circulation to preserve liquidity (and there will surely be much more to come), we don’t hear it so often.

According to Wikipedia, “moral hazard² is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. Moral hazard arises because an individual or institution does not bear the full consequences of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to bear some responsibility for the consequences of those actions.”

So, what is the threat to nonprofits and social entrepreneurs in this financial crunch? A significant, but likely temporary, drop in private philanthropic support? Or is there something more at stake?

The real risk we’re running is the possible dissolution of our hopes to expand opportunity for the young people like those who spoke today. The money that taxpayers (and mostly those not yet born) will foot to work out this mess – and the $2 trillion Iraq fiasco – is money that we could have spent instead to better equip our children for the future. Perhaps even more importantly, the harm posed is yet another cut at our shared belief that the U.S. is committed to at least trying to be a more just. As we have so many times since 1987, what the rest of us may learn from these bailouts is that it is indeed a rigged game – those with more financial and political assets are “more equal” than the rest of us. This increases the pull of cynicism, and that ultimately is very bad for nonprofits who depend on the faith and good will of Americans, much more so than their dollars.

Foolhardy and contradictory as it may sound, though, the main point I want to emphasize here, as I have in previous posts, is that we will still be able to pay these costs AND make investments in our people and infrastructure. It is a question of will; we can do it, if we choose to do it. And for the sake of our children, we can’t afford not to make these investments. It would be immoral not to step up to pay both the cost of those investments, and also the cost of paying the debt we already have shifted to future generations. “Serious” policy people will tell us that we’ll need to live within our means (buckle down, tighten our belts, or other metaphor of your choice) – anything but increase our means. And the temptation to shift the pain to the future, again, is the true moral hazard we need to resist.

1. Bias alert: I am on the board of United Friends of the Children and the Los Angeles Education Corps, a nonprofit that operates the three charter schools sponsored by the LA Conservation Corps.

2. Whatever you think of Wikipedia, its definition was the best of over a dozen dictionary or glossary entries I reviewed. The second paragraph of the definition really was a cut above (see how it works when you plug the finance industry and taxpayers, or the current and future generations, into it): “Moral hazard is related to asymmetric information, a situation in which one party in a transaction has more information than another. The party that is insulated from risk generally has more information about its actions and intentions than the party paying for the negative consequences of the risk. More broadly, moral hazard occurs when the party with more information about its actions or intentions has a tendency or incentive to behave inappropriately from the perspective of the party with less information.”

Peter Manzo is the director of strategic initiatives for the Advancement Project, a civil rights advocacy organization, and a senior research fellow with the Center for Civil Society in the UCLA School of Public Affairs. Previously, he was the executive director and general counsel of the Center for Nonprofit Management. 

Read more stories by Peter Manzo.