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selves forced to go elsewhere to get things that were either unavail-
able nearby or not available in as good a quality or as low a price as
in higher-income neighborhoods. For example, this survey found
low-income consumers spending only about a third of their money
shopping in their local community and two-thirds shopping
elsewhere.
While all this is easy to understand from an economic perspec-
tive, it is also easy to distort from a political perspective. Blaming
the owners of local stores and check-cashing agencies for the
higher charges in such places, compared to charges in safer mid-
dle-class neighborhoods, is usually more politically effective than
blaming those local inhabitants who create the costs which these
institutions pass along to customers”especially if the business
Risky Business 133


owners are mostly of a different ethnic background than the local
people. Even without the incentives of politics, many observers
who do not think beyond stage one blame high prices on those
who charge these prices, rather than on those who create the addi-
tional risks and costs which these prices reflect. From this it is a
short step to advocating laws and policies to restrict how high lo-
cal prices or local check-cashing charges or interest rates will be
allowed to go.
However plausible such laws and policies might seem to those
who do not think beyond stage one, the net result of preventing
local businesses from recovering the higher local costs in the prices
they charge is likely to be a reduction in the number of businesses
that can earn as much locally as elsewhere”or that can even earn
enough to survive locally. Given the existing meager availability of
businesses in many low-income neighborhoods, anything that
forces more local businesses to close aggravates the problems of
the people living there.
Banco Popular, which operates a check-cashing service in low-
income Hispanic neighborhoods, has charged 1.1 percent of the
value of the checks it cashes, plus 20 cents a check. This means
that someone earning $300 a week pays $3.50 per week to get a
paycheck cashed. Meanwhile, someone earning ten times as
much money probably pays nothing, since banks are happy to
have high-income people among their customers and make
money off the large savings accounts and checking accounts
which such people typically have, while the dangers of default
are less. For the low-income worker, the question is whether tak-
ing a bus or taxi to try to get a paycheck cashed will cost more
than the $3.50 paid to Banco Popular, which has armored cars
that drive up to the employer's place of business on pay day.
While Banco Popular's check-cashing service charges for what
many banks provide free, it also takes bigger risks of losses. The
workers who cash their paychecks may be honest and the checks
/34 APPLIED ECONOMICS


genuine, but some of the employers they work for are small fly-by-
night operators, who may suddenly leave town, closing their bank
accounts and taking their money with them, making their workers'
paychecks worthless. Just one such dishonest employer cost Banco
Popular $66,000 in cashed paychecks that could not be redeemed
at the bank where the employer's account had been closed before
he skipped town. That is far less likely to happen with a paycheck
from someone who earns $3,000 a week than with someone who
earns $300 a week. Little fly-by-night operators are unlikely to be
paying their employees $156,000 a year. People with such high in-
comes are more likely to be working for more substantial and reli-
able businesses and organizations.
The risks and costs of cashing checks for low-income people, or
lending money to them, are inherent in the circumstances, rather
than in the particular institutions which handle these risks. When
a reputable bank that normally serves middle class or affluent peo-
ple opens an affiliate in low-income neighborhoods, it faces those
same risks”but without as much experience in dealing with them.
Operating in what is called the "subprime market"”where bor-
rowers do not have as good credit ratings as in the prime mar-
kets”these banks, as the Wall Street Journal put it, began "to
realize that the market was far tougher than they had expected."
Even charging interest rates ranging from 12 percent to 24 percent
in making riskier loans to low-income borrowers”compared to 7
or 8 percent on other loans”the higher rates of default often
made these loans unprofitable.
Bank of America, for example, lost hundreds of millions of
dollars on such loans. In 2001, according to the Wall Street Jour-
nal, Bank of America "said its 96 EquiCredit Corp. offices across
the US. will stop making subprime loans immediately." Other
banks were apparently not quick enough in closing down such
losing operations. A large Chicago bank went out of business,
Risky Business 135

with losses on subprime loans being singled out as the main rea-
son. Losses on such loans were also cited by the Federal Deposit
Insurance Corporation as a factor in the closing of 7 out of 19
banks that failed. The Federal Housing Authority, which usually
lends to lower-income home buyers, has had a repayment delin-
quency rate more than triple that of those who lend to other
home buyers.


RISK-REDUCING INSTITUTIONS
Families, gangs, feudal warlords, insurance companies, partner-
ships, commodity speculators, and issuers of stocks and bonds are
all in the business of reducing and transferring risk.
All face the problem that reducing existing riskiness increases
the willingness of the protected individual to take more risks. An
individual who belongs to a tough gang may become more bel-
ligerent towards other individuals he encounters than he would be
without the protection afforded by the gang's reputation. In me-
dieval times, a peasant might be reluctant to farm in some areas
where there were robbers and marauders around, without the pro-
tection of the armed nobility who take part of the peasant's
produce as payment for their services. Though called tribute, these
payments”usually in kind”amounted to insurance premiums.
Those who are in the business of selling insurance try to take
into account not only the existing risks, but also the increased
amount of risky behavior that the policy holder may engage in as a
result of becoming insured. For similar reasons, the family”the
oldest insurer of all”cautions its members, both when they are
growing up and on specific occasions afterwards, against various
kinds of risky behavior. When families had the burden of taking
care of an unwed daughter's baby, there was more chaperoning,
screening of her associates, and moral stigma attached to unwed
136 APPLIED ECONOMICS


motherhood. All these things declined or disappeared after many
of these costs were shifted to government agencies.


Government Agencies
The incentives of a government agency are very different from
those of a family or an insurance company. As a matter of financial
self-protection, both families and insurance companies must seek
to discourage risky behavior in one way or another. For a govern-
ment agency, however, financed by taxpayers' money, there is no
such urgency about discouraging the increased risks that people
may take because those risks are covered by others. Moreover, the
agency gets its biggest political support from helping, not criticiz-
ing. Thus government emergency programs to help people struck
by floods, hurricanes, and other natural disasters make it easier for
people whose homes have been destroyed to rebuild at the same
locations, in areas where such disasters recur regularly over the
years. Similarly, government programs to develop medicines and
medical procedures to deal with AIDS, at costs subsidized by the
taxpayers, have led to a resurgence of the kinds of risky behaviors
that can lead to AIDS.
Similar incentives produce similar results at the international
level. Where both national and international institutions stand
ready to bail out governments facing bankruptcy and likely to have
defaults on its debts that would hurt banks and other investors in
other countries, the prospects of such bailouts allows private finan-
cial institutions to invest in countries where it would be too risky
to invest otherwise. Sporadic calls for a "restructuring" of debt1 or a
"forgiveness" of Third World debt encourage the debtor govern-
ments to borrow more money than they would if they knew that

1
Essentially paying off old debts with new loans.
Risky Business 137


the loans would have to be repaid or an open declaration of bank-
ruptcy announced, which would make it harder to borrow again,
perhaps for many years. International financial crises, especially
those involving poorer countries, often bring out one-stage think-
ing among those who wish to help less fortunate people, with the
longer run consequences being overlooked.
Since risk is inescapable, the question of how much risk to toler-
ate is a question of weighing one cost against another. Often this
is not done, especially when those who make such decisions do
not pay the costs of these decisions and do not think beyond stage
one. For example, when a certain number of children receive in-
juries from playing in a particular playground, then the swings,
seesaws, or other equipment in that playground may be blamed
and perhaps removed, or those responsible for the playground may
be sued. But, if the offending equipment is removed or the play-
ground shut down because of lawsuits or the fear of lawsuits, will
the children be safer?
Suppose that X percent of the children will receive serious injuries
if they play in this particular playground and 2X percent will receive
equally serious injuries if they stay home. Since no place is 100 per-
cent safe, and none can be made 100 percent safe, the only mean-
ingful question is the relative safety of one place compared to
another and the cost of making either place safer by a given amount.
Our natural inclination may be to want to make every place as safe
as possible but in reality no one does that when they must pay the
costs themselves. We are willing to pay for brakes in our cars, but
having a second set of brakes in case the first set fails would make us
safer still, and a third set would result in still more reduction of risk,
though probably not by a substantial amount. However, faced with
rising costs and declining reductions of risk as backup brakes are
added to automobiles, most people will at some point refuse to pay
any more for additional insignificant reductions in risk.
138 APPLIED ECONOMICS


However, if someone else is paying for reductions in risk, the
point at which risk reduction stops may be very different. Lawsuits
may impose costs that shut down a playground which is safer than
any alternative place the children are likely to be, including their
homes. In short, when someone else is paying, small risks may be
paid for at costs that include incurring larger risks for other people
in the future. The implicit assumption that zero risk can be taken
as a benchmark for assessing blame for particular risks can easily
lead to higher risks than if it was understood from the outset that
one risk must be weighed against another, not compared to zero
risk or even to some arbitrary standard of "acceptable" versus "un-
acceptable" risk.


Ownership Sharing
Sharing ownership has long been another way of reducing risks.
Back in the days of wooden sailing ships, the danger that one of
these ships would be lost at sea was much greater than today. Some
shipowners protected themselves by not owning a given ship alone,
but instead owning for example one-tenth of a share in ten differ-
ent ships. While the increased number of ships meant a greater
risk that one of these vessels would sink, it also reduced the likeli-
hood that the loss would be as catastrophic as if one owned a single
ship outright. Obviously, those shipowners who were rich enough
to own a whole fleet of ships outright could spread the risk that
way.
Modern corporations similarly make it possible for individuals
to spread their risks by owning stock in a number of different busi-
nesses, without owning any particular business outright. However,
employees who own stock in the businesses they work for do not
get the full benefits of risk spreading, since both their jobs and the
money they will depend on when they no longer have jobs”
Risky Business 139


whether due to unemployment or retirement”depend on the fate
of the same company. The consequences of concentrating risks,
instead of spreading them, proved to be catastrophic for many em-
ployees of corporations that went bankrupt amid various well-
publicized scandals among American corporations in 2002.
Not only businesses, but workmen as well, have long pooled
their risks as a way of making them less onerous to individuals.
Mutual aid societies have arisen among workers in a given occupa-
tion or industry, or members of a particular ethnic group, or resi-
dents in a given neighborhood. By paying small amounts into a
common fund, members of mutual aid societies enabled those
among them who were stricken by illness or disabled by injuries to
have the financial consequences cushioned by payments from the
fund. Here the dangers of deliberately engaging in more risky be-
havior were minimized, first of all by the prospect of pain and
death, but also by the fact of being known by other members of
the mutual aid society, who could monitor malingering or fraudu-
lent claims better than larger and more impersonal institutions
could.


Safety Movements
A very different kind of institution for dealing with risk has arisen
in more recent times. This is the private organization or move-
ment devoted to imposing safety requirements through publicity,
litigation or regulation. These include "public interest" law firms,
ideological organizations and movements, such as the so-called
Center for Science in the Public Interest, and government agen-
cies such as the National Highway Safety Administration. Since
these organizations do not charge directly for their services like
mutual aid societies or insurance companies, they must collect the
money needed to support themselves from lawsuits, donations, or
140 APPLIED ECONOMICS


taxes. Put differently, their only money-making product or service
is fear”and their incentives are to induce as much fear as possible
in jurors, legislators, and the general public.
Whereas individuals weighing risks for themselves are restrained
in how much risk reduction they will seek by the costs, there are no
such restraints on the amount of risk reduction sought by those
whose risk reduction is paid for with other people's money. Nor is
there any such inherent restraint on how much fear they will gen-

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