Reducing the Cost of Ex Post Bailouts with Ex Ante Regulation: Evidence from Building Codes

Abstract

The government acting as an insurer of last resort can cause moral hazard if agents respond by taking on more risk or reducing private insurance coverage, thinking they will be bailed out. Theoretically, ex ante measures can ameliorate this problem, but it is not known how effective actual policies are in reducing ex post government spending. Using instrumental variables and detailed building codes data, I show that stricter building codes reduce the amount of money spent by the federal government following a hurricane. Specifically, I find that raising the required wind speed a building must withstand by 1 mile per hour decreases the amount of money subsequently spent by the federal government by 2.2-4% or $14,000-$25,600 per affected zip code during a hurricane. I also show that this decrease is entirely driven by reduced aid to homeowners as opposed to renters.