Having spent a sizeable part of my misspent youth in our nation's capital, I can assure you that the bad ole days of the 1980s-crack cocaine, corruption in municipal government, and pot holes you can bungee jump into-are largely a thing of the past. However, in the mid-to late nineties, there were still a few fearsome idiosyncrasies in Washington D.C.: rodents larger than Gary Condit's conscience (in every quarter of the city except the Northwest where cats reenact a 60s musical every night) and cab drivers who knew of neither juris nor prudence in navigating its pathologically well-organized streets. I suffered through cab rides where the driver thought he was the next Jim Morrison, a driver who was more concerned with playing his keyboard than manning the wheel, a driver who looked so often at the fetching young woman in the front seat that most of the ride was spent in the "British" side of the street and witnessed a driver practically consummate a marriage with his new bride. However, I took all of this in stride. I accepted it as part of the DC Cab mythology. One night, all of my confidence deserted me and I spent a ten minute ride cowering like an Easterner enduring his first Californian earthquake.

What did it take to shake my machismo?

A seat belt. As soon as that cabbie strapped on his belt, I felt my heart drop into my stomach. I searched left, then right-frantically searching for my own belt. Nothing. There were a few scraps of polyester from a past belt but nothing substantive. Can't you see-this adventurer had violated the implicit contract of a rider and a cabbie? I accepted his sitar-strumming, abrupt turns for no apparent reason, and an amazing inability to find change when a tip could be "super-sized." On his part, he accepted my occasional drunkenness, occasional fondling of my companion and poetic directions to well-known monuments and streets (well, if you're at the Department of Labor and look towards...). As long as the driver was as unprotected as I was, I accepted his dangerous dips into oncoming lanes secure in my knowledge that his incentives were very similar to mine: stay alive! Now, there was the much higher likelihood that he could survive an accident and-with insurance-escape without significant harm. All of his capitalist incentives now devolved upon speed to delivery due to the pricing of the cab ride (a larger proportional charge to start the ride). Luckily, I survived this brush with danger but I took away a bigger lesson: moral hazard.

A big, ugly, term that maybe you've heard from Econ 101 or on the nightly news. The concept of moral hazard is really simple actually; it takes place when incentives are misaligned. As in my cab ride, the cabbie faced different incentives from me and-therefore-there was the potential that I could be in for a painful ride. Lest you think this example only exists on former swamp land, moral hazard is all among us. The Savings & Loan crisis could largely be explained by moral hazard: shoddy characters easily secured banking licenses (which gave them government guarantees for their deposits), attracted deposits with higher rates than their conservative brethren (since depositors knew the government protected their deposits-up to a certain size-they didn't pay much attention to the quality of the bank they patronized) and ploughed these deposits into risky loans (high yields rarely come without high risk). We all know how this ended-the American taxpayer footed the bill for billions. Banks have been destroyed as a result of misplaced incentives since the beginning of finance and it will happen again. Despite what Wall Street tells you, there is a trader today facing the a Pascalian choice: If I lose, I lose nothing. If I win, I win everything. Hedge funds, the trendy investment vehicle of choice right now, explicitly operate according to this principle. The uber-investors in whom the wealthy trust their money usually are compensated in this manner. Typically, they receive a percentage based on the assets under management and 20% of the returns above a "high-water mark"-say beating the chosen index by 10%. For this trader, why wouldn't she risk a lot to get above this performance barrier? Either way, she'll receive the original fee and has the potential to earn significantly more. Lest you think only substandard souls fall victim to this peril…When you get insurance on that rental car, are you as careful about scratches? If you had to pay for prescription drugs out of your own pocket, would you be less particular about whether it was brand name or not? I could continue for days but I hope I've made myself clear.

The big lesson I took away from this was pretty simple: think about the incentives of people with whom you're doing business. How is the realtor selling your house paid? How is your broker paid? How is the management of your company compensated?

In an ideal world, your realtor would be compensated based on the present value (time based) of the amount of money he gets for your house, your broker would be paid by how well your assets grow under her care, and management earns as little as possible on a fixed basis, as much on a variable basis and owns a substantial number of shares in the company. See, it's pretty simple: aligning their interests with your own. So, go forth and make selfishness work for you-and avoid cabbies with seat belts.

"Bartleby Dodd" regularly reports on matters pertaining to the economy (or anything else that occurs).

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