Moral hazard (a concept tested in A Level Economics) - how to make money in real estate
BY EUGENE TOH
What’s moral hazard
The definition of moral hazard
Moral hazard is the risk that a party has not entered into a contract in good faith or has provided misleading information about its assets, liabilities, or credit capacity. ... Any time a party in an agreement does not have to suffer the potential consequences of a risk, the likelihood of a moral hazard increases.
Why does the Singapore government pay the full cost for hospitalisation expenses relating to COVID-19?
We’ve actually discussed this in our regular Economics tuition classes when we were covering Microeconomics.
There are probably two key reasons:
Firstly - the government wants individuals not to be deterred from reporting that they actually have COVID-19! There may be people who may choose not to step up to be tested in fear of an expensive hospital stay.
Secondly - it would likely be due to political pressure and to keep death numbers low (these are related).
This policy however, can cause moral hazard
At the start of the pandemic, the government covered the hospitalisation expenses for anyone (including foreigners) in Singapore who happened to contract COVID-19.
This would likely have resulted in a number of individuals from other countries (who suspect they have COVID-19) to come to Singapore especially if their country was not doing active testing during the early stages of the pandemic.
Later on, the government probably caught on that there were foreigners abusing the policy and switched it to a ‘local-only’ policy.
Even so, individuals would less likely guard against a COVID-19 infection or be less cautious, because the monetary ‘cost’ of a hospitalisation stay would now not be part of the consideration since it is paid for by the government.
That is also why the government has recently announced that unvaccinated individuals will have to pay for their own hospital stay if they contracted COVID-19.
The principal-agent problem
Again, in our regular A Level Economics tuition classes every year, we do cover the principal-agent problem. The relationship we examined in class was that of a doctor & a patient. Most doctors we know are good doctors who are ethical - but without ethics & laws governing
Let’s talk about the real estate industry.
When you approach a real estate salesperson (more commonly known as an agent) in search of a property you would like to purchase - you actually enter a relationship. You are now the Principal & the real estate salesperson is the Agent.
Let’s dive a little deeper into what the relationship should be like.
You engage a Real Estate Salesperson - why? You are searching for a property to buy. The real estate salesperson knows more about the property market than you do. What does the real estate salesperson know?
Government regulations - to ensure that your housing purchase is smooth, and you don’t end up paying more taxes because you are unaware of certain regulations (like the ABSD)
An awareness of loans & interest rates - calculate your financial commitments to see what you can afford
Understanding of the different districts in Singapore & various amenities available - to find a property that is suitable for you
Common problems with properties to look out for - like water leakages, sound problems (like fighter jets or a busy road) or even a lousy developer with poor track record
Yet - once you learn about the commission rates that real estate salesperson can possibly earn from a developer - you will understand why there is the potential for moral hazard.
Property developers can pay between 2% to 8% of the price of a property that an agent ‘closes’ the deal for.
A 2% commission for a $2million property will be $40,000 while 8% commission will be $160,000.
Will the Real Estate salesperson maximise your interest since he is helping you to make a decision? Or could the Real Estate salesperson deliberately conceal any ‘negative’ points about the property to ‘close the deal’, thereby maximising his own self-interest?
I have a friend (her name is Beverly) who is a Real Estate Salesperson and she’s an honest one, who will present all the information you need. She’s a friend since secondary school & is an honest person. But I really can’t quite be sure that all real estate salesperson out will maxmise the interests of the ones they are representing.
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