Moral hazard, 38 Studios and wasteful public spending

Guest Column: Ken Block
A “moral hazard” is defined as a lack of incentive to guard against risk where one is protected from its consequences. More

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Moral hazard, 38 Studios and wasteful public spending

Guest Column: Ken Block
Posted 6/11/12

A “moral hazard” is defined as a lack of incentive to guard against risk where one is protected from its consequences.

The 38 Studios LLC implosion is a prime example of moral hazard. The state of Rhode Island played venture capitalist (badly) and committed $75 million of taxpayer money to the deal. 38 Studios failed to find private equity to finance its operation – even after Rhode Island jumped in with both feet. Other state governments like Massachusetts took a pass on the 38 Studios deal.

Any experienced investor with an aversion to risk would have passed on personally investing in the 38 Studios deal. I suspect that none of the sitting members of the board of the R.I. Economic Development Corporation at the time the investment was made would have put any of their personal fortunes on the line for this deal.

A key question to ask is why did Rhode Island take the risk? Why did the board members of the EDC commit to the deal? While I am sure that political pressures factored into the mix, the best answer I can come up with is because the dollars put at risk did not belong to anyone making the decisions – hence the moral hazard.

As information trickles out, it appears that very little oversight was exerted by Rhode Island over 38 Studios. Also, Rhode Island took no equity stake in the business, something that any private investor would have insisted on for financing such a large percentage of the operation. Moral hazard is the best explanation for why this was possible. It appears that no one on the governmental side felt the imperative to protect the invested dollars.

It is too easy to be careless with other people’s money – particularly when the money involved comes from a great many people in the form of taxes. Examples abound of government- spending programs fraught with waste and fraud. One of my favorite examples is the Lifeline program, run by the Federal Communications Commission, that provides cellphones to qualified, Americans with low incomes. On Lifeline’s website, the first line of the page states that Lifeline’s goal is to “eliminate waste, fraud and abuse, saving up to $2 billion over three years.”

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