November 22, 2005

November 22, 2005 | Commentary on

Future is Littered With Moral Hazards

Fourth in a Series

Stock analysts used to say, "As General Motors goes, so goes the country." Political analysts soon may be saying the same thing. GM's pension and retirement promises have much in common with Washington's Social Security and Medicare promises: In the long term, none can be kept.


That's especially troubling because spending promises are moral promises, and our government's overspending and overpromising today is creating a moral hazard for all Americans. Part of that is caused by the growing belief that the federal government should solve every problem, an idea that endangers the very concept of personal responsibility.


Hurricane Katrina highlights both the spending problem and the moral hazard. Thousands of people lost everything, and the federal government jumped in to help. It offered tens of billions of dollars in aid -- at one point spending so much so quickly it was virtually impossible to track where it was all going.


Why Plan Ahead?


Some of the proposed federal recovery plans were insane. Rep. Gene Taylor, D-Miss., went so far as to propose making federal flood insurance retroactive. His bill would have let Gulf Coast residents purchase insurance simply by paying 10 years' worth of premiums, with a 5 percent penalty.


In other words, people who decided not to purchase insurance beforehand would be treated almost exactly the same as those who had planned -- and paid -- ahead.


This would defeat the entire purpose of insurance. Imagine if you could buy homeowners' insurance after a tree hits your roof, yet pay almost the same premiums as people who'd been buying coverage for decades. Why would anyone ever pay for insurance ahead of time?


Of course, the government already has a moral responsibility here, since federal flood insurance has encouraged many to live in places they probably shouldn't. There are now almost half a million homes within 500 feet of the coast. That's asking for trouble when a big storm blows through. But when it does, all too often Uncle Sam picks up the tab for rebuilding.


Federal Medicaid policy also has created a moral hazard for many middle-aged Americans. Untold thousands have "cooked the books" to protect their assets from nursing-home operators. Financial specialists convert "countable assets" of the well-to-do elderly into "noncountable" assets, or "inaccessible" assets before their clients enter nursing homes.


These assets then can be passed on to children and grandchildren, while Medicaid (i.e., the taxpayers) picks up the nursing-home tab. It's legal, but it's hardly ethical.


Which bring us back to GM. Last month auto-parts maker Delphi declared bankruptcy. That may allow it to escape the expensive pensions it promised workers while it was part of GM. (Delphi was spun off in 1999). Other companies have done likewise this year, including United, Delta and Northwest Airlines.


For years, these companies bought peace with unions by promising gold-plated pension and retirement benefits both sides knew they couldn't afford. As far back as the 1940s, GM President Alfred Sloan warned pensions would become "extravagant beyond reason."


Yet companies and unions worked together to increase pension promises anyway. As recently as 2002 a financially struggling United Airlines granted many employees a 40-percent increase in pension benefits.


Now, through bankruptcy, many companies are passing those obligations on to the federal Pension Benefit Guaranty Corporation. That agency is supposed to be financed by the corporations it protects.


It's On The Kids


But because PBGC is vastly underfunded -- it's an estimated $23 billion short today, and the General Accountability Office predicts its shortfall will reach $87 billion over the next decade -- it's we the taxpayers who are really on the hook here. A similar moral hazard is rearing its head among state and local governments, and it should prove a cautionary tale to federal lawmakers about the dangers of overpromising.


Barclay's Global Investors estimates that state and local pension funds are underfunded by some $460 billion.


By law, these governments cannot default, and they cannot pass along their obligations to Washington as private companies are doing. So our children and grandchildren eventually will pay those bills through higher state and local taxes.


Through its spending and borrowing today, and through its entitlement promises under Social Security and Medicare, the federal government is creating a similar moral hazard for future generations. Our current overspending is a symptom of this underlying moral problem. Next week we'll begin looking at ways to control spending and start solving these problems.

Ed Feulner is president of The Heritage Foundation (, a Washington-based public policy research institute.

About the Author

Edwin J. Feulner, Ph.D. Founder, Chairman of the Asian Studies Center, and Chung Ju-yung Fellow
Founder's Office

First Appeared in Investor's Business Daily