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Is the Market the Cause of Hurricane Damage?

June 12, 2006

An interesting challenge to the idea that markets can produce safety and quality comes from a report from the federal buildings inspection team. The National Institute of Standards and Technology, part of the Commerce Department, looked at homes that were damaged in Katrina and Rita last year. They found that many of them were not built to the highest standard of construction. Not surprisingly, they complain about unlicensed roofers and unregulated building, and demand a full-scale crackdown.

The report argues that we certainly need local and state regulations, certifications, and licenses. Maybe we need a national system even. Whatever the case, the report argues, the government is going to make sure that the new structures it pays for are built with attention to quality. We can take it for granted that the people who wrote the report believe that the free market failed.

Did the market fail?

Before examining this claim, notice that backward-looking reports like this are easy to generate. If only we had expected the unexpected, bad things might not have happened. If there had been a moat around my house, my house would have been spared the fire that first consumed my neighbor's house. If I had not been driving that day, I would have avoided that car crash. If I had worn a bulletproof vest, I would have rushed that guy who robbed me at gunpoint.

Unexpected events occur in life. Preparing for every possible contingency is not only too expensive; it is crazy, as in obsessive-compulsive. We don't drive around in steel tanks because we prefer the lower expense and ease of smaller cars. We prefer driving to the safer alternative of staying home because we need to get somewhere and we willingly take the chance.

In the case of hurricanes, homeowners might actually prefer to pay less for an already expensive roofing job by employing a less experienced or less thorough worker or by requesting cheaper materials. If the roofer bangs in the nails well enough to hold at most times — even if the roof gives way in a hurricane — that is a risk that might be economically worthwhile for the home owner. Indeed, most homeowners are interested in cosmetics; the underlying construction is something that people would otherwise gladly scrimp on.

Is this a market failure? Not necessarily. Life consists of tradeoffs. Whatever resources are expended in one area cannot be expended in another area. Provided the homeowner is bearing the full liability, choosing shoddy construction is certainly his right. If he makes a mistake, no one pays but the homeowner.

However: liability is a big proviso. Most homes are not owned outright; rather the owner holds a mortgage that is marketed as a financial instrument. And how does the owner of the financial instrument assure the quality of his investment? The critical institution here is insurance. It is the insurance company that provides the market service of bearing the liability in the case of unexpected disaster. It is up to the insurer to make the calculation concerning the likelihood of this or that contingency: whether it is fire, hurricane, flood damage, theft, or whatever.

It is for this reason that homeowners spend far more on construction and upkeep than they otherwise would. Homeowners may only care about landscaping and paint color, but the insurer cares about the thousands of tiny issues that appear in the inspections that take place before the bank approves a mortgage.

What if the inspection is not thorough? Well, there is a competitive market for inspections as well. Insurers work with mortgage lenders to find the best ones. An inspector who does not do his job will be pushed out, while those who do more thorough inspections and catch more issues will gain reputations.

This is not speculation. This is how the market works every day, when it is allowed to. Homeowners are constantly jumping through hoops that they otherwise wouldn't care a flip about, solely because banks and insurers do care. And it's even true for those homes that do not carry a mortgage. Homeowners insurance is a way for every homeowner to slough off the liability of financial losses coming their way through unexpected events like extreme weather.

Unfortunately, the report in question does not break down its data based on whether and to what extent the homes with the bad roofs were privately insured, publicly insured (many properties in flood-prone areas would not be affordably insured in a market setting), or not insured at all. Some of these markets are free; some are not. The incentives change wildly depending on the institutional constraints.

The state: we don't need it: $13

It's not clear that this issue even occurred to the writers of the report. Instead, they took the simple way out. They observed that a roof blew off and concluded that it should have been nailed on better! That's a pathetic excuse for a "report" but exactly what we can expect from any such government study.

What about the recommendations of the report? Existing roofers who can comply with a certification requirement might be thrilled about state and federal regulations. That diminishes competition and keeps a high barrier to entering the field. It is one step closer to monopoly, which is what many established producers in all sectors would like.

But will the homeowner be better off? Not likely. We have no way of knowing whether the government would choose the right standards because the government does not respond to market feedback mechanisms. Bureaucrats are notoriously bad at assessing tradeoffs, especially when it pertains to risk. They are forever preventing yesterday's disaster while doing nothing to attempt to foresee tomorrow's.

All we need to know about the idea of a nationalization of building codes is summed up in this key fact. There would have been very little damage from Katrina had the levies not broken — and these were built entirely by the federal government. So let's leave the poor roofers in Louisiana, Texas, and Florida alone and start focusing on the real problem: the existing legal structures that prevent the market from doing its job.

Lew Rockwell is president of the Mises Institute and editor of LewRockwell.com. Send email to Rockwell@mises.org. See Lew's columns on Mises.org. Comment on the blog.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.

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