copyright notice
link to published version: IEEE Computer, February, 2014

accesses since January 6, 2014


Hal Berghel

Modern economics includes the art of making common sense abstruse. Terms like moral hazard and negative externality are two examples. Both describe states of transactional imbalance. But this imbalance isn’t limited to economics. When governments are involved, this can lead to social instability.


Pedantic economists may explain moral hazard in terms of information imbalances and the like, but don't be fooled. The meaning is much simpler. A moral hazard is an environment in which the benefits and risks are disproportionately distributed amongst participants –one side gets the reward and the other gets the risk. It's just that simple. Any school child will confirm that moral hazards are inherently unfair. But at the hands of a political camoufleur, moral hazards become the coin of the realm of politicians, business lobbies, and PACs.

A classic illustration of the role of moral hazard may be found in the passage of the depression-era Glass-Steagall Act that separated investment from commercial banking. Congress agreed to insure commercial banking deposits to assuage depositors and avoid bank runs. G-S allowed commercial banks to transfer their major risk to the government. To make the increased risk acceptable, Congress insisted that commercial banks be heavily regulated

Flash forward to 1999 when the banking interests convinced Congress to overturn Glass-Steagall with the Gramm-Leach-Bliley Act that deregulated commercial banking. From that point on, commercial banking could not get enough of risky investments: collateralized debt obligations, derivatives, junk bonds – you name it. But the deposit insurance remained as in G-S. As David Stockman put it in his recent book The Great Deformation, all that was left after GLB was naked moral hazard! The banking interests and politicians kept the moral hazard hidden from the public until the financial meltdown of 2007 – the major negative externality of GLB so far.

Where moral hazards offload risk, negative externalities offload the cost of collateral damage. The superfund cleanup sites are all examples of negative externalities of commerce where the taxpayer is stuck with the tab for undoing the damage caused by profit-makers. In a quest for symmetry, economists have developed elaborate models that explain costs in terms of negative and positive externalities, but this is a ruse. Negative externalities are real and consequential while the positive externalities are usually contrived, infrequent, and trivial.


The 1975-76 Congressional hearings into domestic surveillance by Sen. Frank Church, Rep. Otis Pike, and Rep. Bella Abzug were an attempt to address the moral hazards and negative externalities created by government surveillance.

President Gerald Ford tried unsuccessfully to distract Congress from investigating the government intelligence community with his creation of the Rockefeller Commission in 1975 after Seymour Hersh's revelations about the domestic surveillance of the antiwar, minority, and women's liberation movement by the CIA. Operation Chaos disabused Congress from deferring to executive privilege, and prompted investigations in the House (Pike) and Senate (Church) Intelligence Committees, and Bella Abzug's House Subcommittee on Government Information and individual Rights. Although initially targeting the CIA, these investigations quickly led to the NSA's domestic surveillance activities – exactly what the Ford Administration and the Rockefeller Commission wanted to avoid.

Committee testimonies by CIA Director William Colby and NSA Director Lew Allen gave up some “family jewels” like Operation Shamrock's domestic surveillance program, Project Minaret's watch lists of US citizens, and the FBI's COINTELPRO operation to subvert political dissent. By the time Bella Abzug's committee heard testimony from the telephone and telegraph company executives, the true extent of the illegal surveillance became clear. This motivated the Foreign Surveillance Intelligence ACT (FISA) introduced by Sen. Edward Kennedy and signed into law by President Carter in October, 1978.

There we have it. The intelligence community's surveillance and attempt to discredit political dissenters was a negative externality that began as legitimate government intelligence gathering. However, the inclusion of Jane Fonda. Dr. Spock, and Rev. Martin Luther King in the sweep went a step too far for Congress. Because of inadequate oversight the intelligence agencies were found to be using public funds for political ends - the moral hazard.

There was no penalty to constitutional abuses by the intelligence agencies. Congress introduced FISA to restore a sense of balance. FISA was always a fragile creature of compromise that could only possibly work in the context of strict “minimization” and a self-constrained intelligence community. Its partisan nature - since its inception the FISA justices have all been appointed by conservative Supreme Court Chief Justices (Burger, Rehnquist, and Roberts) – and the fact that deliberations were always ex parte (only the government was allowed to participate), made it vulnerable to pro-government bias and invited onstitutional abuse. Still, it did tend to prevent some egregious abuses until 2001 when legislation such as the Patriot Act rendered it basically impotent.

The Patriot Act and related legislation left behind naked moral hazard in intelligence gathering just as GLB had done for banking.


In a judicial surprise, conservative District Court Judge Richard Leon's opinion (Klayman et al v. Obama et al) ruled on December 16, 2013 that the NSA's harvesting of metadata may violate the Fourth Amendment ( ). The provocative part of the opinion begins at page 35. Leon's opinion challenges the relevance of the 1979 Supreme Court decision Smith v. Maryland) to the NSA's Bulk Telephony Metadata, because the latter is far more expansive than anything anticipated in the Smith decision. Leon likens the NSA surveillance to an “almost Orwellian technology” (p. 49). Leon then asserts “…the Government does not cite a single instance in which analysis of the NSA's bulk metadata collection actually stopped an imminent attack, or otherwise aided the Government in achieving any objective that was time-sensitive in nature.” (p. 61) In other words, Leon agrees with the civil libertarians that the NSA bulk metadata surveillance program accomplished little at an enormous cost in loss of civil liberties. Hold that thought.

On December 27, 2013 federal judge William H. Pauley dealt with the same issue in ACLU, et al v. James R. Clapper, et al ( ) . What a difference a week makes.

Pauley is convinced that the metadata program is constitutionally valid, and that the plaintiffs have not made a statutory argument that their rights were violated because Congress specifically blocked the opportunity to make such claims by precluding all citizens from participation in the FISA process in the first place. The government, according to Pauley, had sovereign immunity (pp. 21ff).

Further, Pauley disagrees with Leon regarding the relevance of Smith. The volume of data is and nature of the technology is irrelevant according to Pauley (p.44). Moreover, Pauley accepts government claims that the bulk telephony metadata collection is effective at face value (p. 50). And, he argues, even if there were less intrusive means to achieve the same results, that wouldn't matter (p 41) for the government is under no obligation to use it. Pauley also reaffirms that under Smith “…when a person voluntarily conveys information to a third party, he forfeits his right to privacy in the information….The collection of breathtaking amounts of information unprotected by the Fourth Amendment does not transform that sweep into a Fourth Amendment search” (p. 42)

But the clincher is his claim that the executive power of the President “reaches its zenith when wielded to protect national security (p.48)….the right to be free from searches and seizures is fundamental, but not absolute (p.51).” This wording is reminiscent of the divine right of kings. So on Pauley's account, FISA defendants have no Constitutional rights, and government claims of the value of surveillance programs is sufficient to justify them (pp. 48-49).

I can't speak to the validity of Pauley's legal reasoning, but his narrative is inconsistent with the historical record For example, he claims that “There is no evidence that the Government has used any of the bulk telephony metadata it collected for any purpose other than investigating and disrupting terrorist attacks.” (p. 50-1), where contradictory evidence has been widely reported in the media. For example, Reuters correspondents John Shiffman and Kristina Cooke published an investigation on the NSA's distribution of extrajudicial information to the US Drug Enforcement Agency (DEA) for purposes of criminal prosecutions that have nothing at all to do with national security ( ).

Equally troubling is Pauley's claim that the bulk metadata program might have permitted the NSA to notify the FBI that 9/11 terrorists were living in San Diego. According to journalist James Bamford, the leading chronicler of the NSA, the CIA and NSA were aware of the terrorists in San Diego before 9/11, but didn't notify the FBI. Ironically, the terrorists were actually living in room rented to them by an FBI informant! (A Pretext for War, pp.229-231) According to Bamford, the breakdown wasn't technical, it was procedural. Pauley later cites unsupported government claims as definitive evidence of bulk metadata effectiveness (pp. 48-49).

So there you have it – judicial confusion. Leon and the civil libertarians vs. Pauley and the government intelligence community. It should be noted abuses of civil liberties were anticipated by Senator Russ Feingold at the very time the Patriot Act was debated in the Senate in 2001 ( )! Recently, several members of Congress have indicated that the Executive Branch mislead Congress on the matter of legal interpretations of the Patriot Act. Pauley responded to this in his decision as well: Congressional ignorance of the law is no excuse (p. 31ff). This was after he ruled in an earlier case that Congress is not entitled to see relevant classified reports regarding Executive (fn, p. 31). Congress would have been well served by listening to Feingold.


Prior to the judicial opinions, on December 12, 2013 the Obama Administration released the report entitled “Liberty and Security in a Changing World" ( ). From the civil libertarian perspective the bad news is that it calls for no substantive changes to current policy. The good news is that if any or all of the recommended changes are made, we shouldn't be much worse off than we are.

It would be a mistake of the first order to assume that this report is an objective, independent, unbiased review of the NSA policies as the committee members were political friends of President Obama. Given the President's strong support for the NSA surveillance programs, he could be expected to avoid selection of anyone who might wander off page.

The report is not without strengths -e.g., emphasis on multiplicity of risks (pp. 46-) and that the Bill of Rights are not subject to “balancing” against competing government interests (p. 49). But the repeated appearance of informal fallacies detracts from its value. On page 75, for example, in response to criticism that the NSA surveillance is both indiscriminate and pervasive, the report responds “NSA focuses on collecting foreign intelligence information that is relevant to protecting the national security of the United States and its allies.” This is a textbook case of question begging. What the NSA “focuses on” is precisely the issue in question. Saying that the NSA does no wrong because what the NSA does is right may is semantically, if not viciously, circular. The very next sentence is “Moreover what the NSA collects is shared with governments of many other nations for the purpose of enhancing their national security and the personal security of their citizens.” Here the fallacy of irrelevance rears its ugly head. The presence of illogic in the Presidential Report is likely due to the fact that the committee members were lawyers and political insiders – careers in which illogic bears little if any penalty, and in some circles, is highly sought after. We'll pass over the remaining bulk illogic in silence, in search of substance.

Another deficiency of the report is that it focuses on minor tactical modifications that might make the programs more acceptable to an alarmed public. This report is better understood as palliation than reform. Consider the following.

You can see where this is going. Recommended changes tend toward the cosmetic. Through it all, page after page, any mention of judicial oversight remains ex parte, and suggestions for congressional reforms are strategically inert.

A few progressive changes appear under Organizational Reforms.

The report concludes with technical recommendations. #29 recommends that the government do nothing to “subvert, undermine, weaken, or make vulnerable generally available commercial software.” And here we thought that was obvious!

The authors of the report claim that they are “unaware of any vulnerability created by the US Government …” (p. 217) The timing of these remarks is interesting given recent revelations about the TAO project ( ) and the Reuters report that the NSA paid the RSA to embed a flawed random number generator in its encryption software ( ) to make it easier to break. Ars Technica subsequently ran a story that suggests that the co-chair of the IETF cryptography panel was an NSA mole who was instrumental in ensuring that the NSA has a backdoor to common security products ( ). And just when we thought we had the NSA Clipper Chip behind us!

There are several recommendations to review the process of issuing and maintaining security clearances, which looks like a good idea. At this point, over 1% of the US population has a clearance – probably way beyond the limits of prudence. The suggested employment of a “work-related access” model is also a welcome idea, although the problem was never in the security model but rather in enforcement and accountability (see this column, March, 2012).

As expected from the membership of the committee, this report falls in the Shakespearean category of much ado about nothing. Though it doesn't accomplish much, it doesn't seem to do much harm either, and that's a good thing.


Noteworthy moral hazards are much harder to detect and less likely to inflame than noteworthy in-your-face negative externalities. The 2007 collapse of the financial sector didn't escape anyone's attention, but the causal connection with the passage of Gramm-Leach-Bliley Act is still denied by those who benefitted from its passage. Similarly, the world took note of the NSA's interception of Angela Merkel's phone calls, but few seem willing to draw the connection between it and such draconian legislation as Patriot Act, the Protect America Act of 2007, and the FISA Amendments Act of 2008.

Chelsea Manning and Edward Snowden are predictable negative externalities of unjustified surveillance in the same sense that are consequences of unjustified wars. Privacy and civil rights abuses and a fear of Orwellian totalitarianism incite some people to take drastic measures. The way to deal most effectively with these consequences is to call attention to the initiating moral hazards, and bring them in line with public expectations of civil liberties.