Wednesday, July 27, 2005

How Ethics Can Help Your Pocketbook

R. Aaron Levine, whose new book Moral Issues of the Marketplace in Jewish Law is in production by Yashar Books and will be released shortly, was kind enough to share with me a short article of his that is set for publication in the Journal of Economic Psychology. In this article, he critiques an article by Morris Altman in the same issue of that journal that proposes a major revision to neo-classical economic theory.

One of the many points that R. Levine makes in his critique is that honesty and integrity in the marketplace serve to mitigate default risk. Presumably, he is referring more to consumer default risk (e.g. credit cards, auto loans, mortgages to a lesser degree) than corporate default risk. Both segments of default risk contain a combination of financial and ethical risk--will the entity have the ability to repay loans and how hesitant will the entity be to default on a loan. I suspect, though, that the ethical component is much more prominent in the consumer segment than the corporate.

R. Levine's point--that ethics can benefit the public by reducing default risk--can be easily seen when considering the example of credit cards. Anyone who is more than 60 days overdue with a payment (details vary based on the issuing bank) will be hit with an onerous interest rate. Why? Because there are thousands of people who declare bankruptcy each year and whose loans will never be repaid to the issuing banks. It is the rest of the consumers who must foot that bill and repay those loans to the bank (otherwise, the bank will simply exit from the market). Currently, many people, when realizing that bankruptcy is imminent, take the opportunity to max out all of their available credit before announcing the intent to default. That is unethical. Some, hopefully only few, build up significant debt with full intention of declaring bankruptcy and not repaying the loan (state laws vary on the efficacy of such bankruptcies). All of these losses are paid by the rest of the consumer base and is built into their interest rates. If these unethical defaults no longer occur, credit card interest rates will drop significantly to the benefit of many if not all consumers.

So there you have it: If people were more ethical, the economy would be better because of less default risk. And that is without even getting into eliminating actual fraud.

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