Irrational Economist_ Making Decisions in a Dangerous World - Erwann Michel-Kerjan [83]
Nor is there any lack of good policy alternatives. One reasonable option would be to make private disaster insurance mandatory and to create a federal reinsurance program, allowing private insurers to transfer some portion of the risk to the government reinsurance agency, in return for an appropriate premium. Howard Kunreuther suggested a solution along these lines as early as 1968, and I proposed my own variant on the idea three decades later.23
The most difficult challenge, however, is not designing the program but finding a way to give the relevant ideas political salience. So long as public discussion of disaster policy is set within the context of a specific disaster, it is hard to imagine lawmakers not focusing on the disaster’s victims and their immediate needs. Only by looking across multiple disasters will lawmakers—and the American public—begin to see advantages in reforming the way the federal government finances disaster losses. As a result, constructive reform of federal disaster policy may, ironically, become more likely against the backdrop of a fiscal disaster than of a natural disaster. Whereas a natural disaster focuses our attention, appropriately, on how best to assist the victims, a fiscal emergency could focus our attention on the enormous long-term costs of disaster relief, across many disasters. Thus, as we now move into a period of unprecedented fiscal challenge, it may be a particularly good time to take up disaster policy anew.
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Catastrophe Insurance and Regulatory Reform After the Subprime Mortgage Crisis
DWIGHT M. JAFFEE
INTRODUCTION
The U.S. federal government and individual states now actively participate in providing catastrophe insurance for all major natural disasters (earthquakes, hurricanes, and floods) as well as terrorism. At this time, the subprime mortgage crisis is also creating catastrophic effects in U.S. loan markets and associated goods markets that clearly require governmental intervention. The experience with catastrophe insurance markets is useful for re-regulating loan markets facing severe distress because originating risky loans with highly correlated loss patterns is tantamount to writing catastrophe insurance.
LESSONS LEARNED FROM CATASTROPHES AND GOVERNMENT CATASTROPHE INSURANCE
Although the focus of this section is on the lessons learned from governmental provision of catastrophe insurance, it is useful to start with those learned regarding the behavior of economic agents—individuals, firms, and government—in anticipating past catastrophes and providing emergency aid in the immediate aftermath of the events. Subsequently, I will address the lessons learned regarding catastrophe insurance and how this may help inform the regulatory reform of the U.S. financial system.
Lesson 1: Limited Preparation and Mitigation in Anticipation of Catastrophic Events
It is remarkable the degree to which individuals, firms, and governments fail to take precautions to avoid catastrophic natural disasters or to mitigate their effects, even when historical precedents indicate that future events are likely. For one thing, homes and commercial structures continue to be built on earthquake fault lines and flood plains and within hurricane belts. In addition, the available insurance is often not purchased and cost-effective mitigation investments are often ignored.1 As an example of a specific failure, recall that the World Trade Center was the focus of a serious terrorist attack eight years before the fateful attacks of September 11, 2001, and yet few precautions were instituted to stop a new attack or to mitigate its effects.
In the same fashion, few precautions were taken to avoid or mitigate the effects of the subprime mortgage crisis. A clear warning sign was the bubble in U.S. housing