Shipwrecks in the mid-19th century were a common occurrence, in part due to attractive insurance policies.
In general, being a seaman was a pretty rough job. Long hours, hard work, high likelihood of expiration—that sort of thing. But the popularity of commercial insurance, of all things, made seafaring unusually deadly in 19th century Britain.
What had happened was this: commercial insurance came around. Owners of ships who had insured their vessels realized that they might earn more money if the ship sank than if the ship made it to its destination. Especially if the ship was old and shoddy. So what they did was stuff the ship with a lot more freight than it could safely hold and send it off. If the ship made it, the owners made more money because they fit more freight on it. If the ship sank, they were reimbursed a tidy sum for a cranky old ship that wouldn’t have made it much longer anyways. It was a win-win for the shippers. Not so much for the sailors and insurance brokers.
In laymen’s terms, this scenario is called an unintended consequence. In philosophy and economics, it’s called a moral hazard. A moral hazard is when a person is given an incentive to act recklessly because that person doesn’t bear responsibility for his actions. Because shippers had no (financial or physical) skin in the game, they gladly sent sailors off to less than uncertain futures for the sake of profit.
Countrywide was infamous for its unscrupulous lending practices. But it takes two to tango.
We have a modern analogue, unfortunately. Remember the financial crisis? Mortgage originators sold a lot of risky mortgages to people who probably shouldn’t have been able to get a mortgage. (Wall Street came in and bundled those mortgage into complex securities that they traded on the open market.) If the mortgages tanked, the risk of defaulting lay with the borrower, not the originator. But originators and brokers made a lot of money if people took out more mortgages. So mortgage originators went absolutely wacko for a number of years and tried to sell really bad mortgages to some really gullible people because originators wouldn’t be on the hook if those people defaulted.
But this is not a perfect analogy. In the run-up to the financial crisis, mortgage originators and brokers weren’t forcing people to buy mortgages. They were pushing unhealthy mortgages on people, and misled people about the attractiveness of certain mortgages with “adjustable rates.” Ultimately, however, borrowers also did some pretty reckless things on their own, like take out a second mortgage they couldn’t afford or use their house as another line of credit. Both lenders and borrowers deserve blame. It takes two to tango.
Samuel Plimsoll was a thinking man.
Lo and behold, the 1871 Merchant Shipping Act actually forced contracted sailors to complete voyages under penalty of imprisonment and fines. It was common practice for sailors to sign contracts with a shipper or else they might not get paid; once the contract was signed, the sailors’ hands were tied. Essentially, shippers got to decide whether they were going to play chicken with the crew’s life, and the law forced sailors to play along.
In walked a guy named Samuel Plimsoll. Plimsoll was a thinking man, and eventually got elected as an MP in 1868. Plimsoll decided to do something about the moral hazard that was giving shippers an incentive to be immoral louses. Plimsoll designed a marking on the ship’s hull that would let inspectors know if the ship was overloaded: if the water went above the mark, the ship was too far underwater, which meant that it was too heavy.
After the Plimsoll line, it was easy for insurance inspectors to see whether ships were being overloaded. Insurance companies decided that ships without the Plimsoll line, or ones in which the Plimsoll line was underwater, weren’t worth insuring. Shippers caught wise and stopped overloading ships, because it simply didn’t pay to be risky anymore.
The Plimsoll line, a circle bisected by a straight line.
What will happen with the debris of the financial crisis and the mortgage market? The Dodd-Frank bill was passed in 2010. Stricter lending standards now exist so that only those borrowers likely to repay their loans will be given a mortgage in the first place.
But it’s tough to say that this piece of regulation will put an end to moral hazards in the financial sector. The “efficient” benefits of the modern financial system—easy accessibility of cash, digital handling of money, the interconnectedness of global markets—all come with an Achilles heel: they help us feel more removed from money than ever before. This distance from the source of our livelihood is a considerable problem. In order to keep moral hazards from laying waste to economies around the world, we need to find a way to protect efficiency while imbuing transactions with a sense of proprietary responsibility.
