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Friday, October 21, 2011

Obama does not understand adverse selection

We economists discovered moral hazard and adverse selection in the mid-1980s. These terms came to us from the insurance industry and fit in well with our growing interest in information economics.
Of the two concepts, moral hazard has gotten more play than adverse selection. “Moral hazard” is a term used frequently in the business press. It explains current and past financial crises by showing that bad things happen when investors expect bailouts by lenders of last resort. The Southern European countries expect bailouts from their northern neighbors. Private mortgage lenders expect automatic bailouts from Freddie and Fannie. Buyers of Asian sovereign debt in the 1990s expected international agencies to bail out the lending countries.
Obamacare has brought adverse selection to the forefront. It explains and will continue to explain why Obamacare will not work. Adverse selection is routinely taught in law schools. I would imagine that President Obama encountered it in the course of his law training.

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