Do HOA's create moral hazard?

This past week, a letter was circulated by a homeowner (or homeowners) regarding the adoption and pending vote on a veto of Park Lane's rules and regulations. Another homeowner, in opposition to the veto, tried unsuccessfully to reply to the author(s) of the letter and instead forwarded the letter to the board of directors via email. I, personally, did not find the letter very persuasive as most of the arguments in it were ad hominem in nature. However, one of the comments made by the homeowner got me thinking about the nature of the relationship not only between individual members of the association but also between the members and the association, as a bureaucratic entity. Specifically, does the existence of an HOA create moral hazard?

Wikipedia defines moral hazard as occurring "when a party insulated from risk may behave differently than it would behave if it were fully exposed to the risk". This situation generally occurs in finance and insurance when people take risks, the costs of which are borne by others (e.g. an insurance company); however, I think it is equally applicable here. As an aside, the costs associated with these risks can sometimes be referred to as negative externalities which are defined, again by Wikipedia, as "[a cost] incurred by a party who did not agree to the action causing the cost".

Now, consider a simple example of your neighbor parking his car in front of your house or letting his dog defecate in your yard or having a loud party. Your neighbor has created a "negative externality" for you (note that this is not usually or necessarily malicious). You have a number of options to address the issue:

1. Ignore it, and hope it goes away.
   
   • Risk: The problem won't go away.
     
2. Talk to and resolve the problem with the neighbor.
   
   • Risk: You might have to step out of your "comfort zone" and/or your neighbor might be a jerk.
     
3. Call in the authorities (police, code enforcement, humane society, etc.).
   
   • Risk: If your neighbor finds out who made the complaint (possible in the case of a police visit and/or report), he'll be upset at you regardless of whether or not he is a jerk.
     
4. Retaliate with either passive or overt aggression.
   
   • Risk: Escalation may lead to more and bigger issues.
     

(In my opinion, the risks and costs of option 4 far outweigh the benefits, assuming there are any, so I'm going to rule that option out for the purpose of this discussion.)

In the absence of an HOA you bear the risks for all three of the "viable" options. Knowing this, most people will progress through these three options in the order listed, and I would wager that most issues would be resolved amicably without moving past step 2. However, consider the same situation in which an HOA is present. As with the absence of an HOA, you are fully exposed to the risks of the first two options, but in associations in which complaints are kept private (as is the case in Park Lane), you bear none of the risk(s) of pursuing option 3. Armed with this information, it is only logical to assume that people living in HOA's when confronted with issues such as this will jump directly to this option.

But, aren't HOA's supposed to protect property rights and keep people from interfering with each other? The answer is, of course, yes. This is the wrong question to be asking, though. The real problem is that when people are not fully exposed to the risks and costs of their actions, they act differently than they otherwise might (see: moral hazard). In the case of an HOA, this can lead to all sorts of petty complaints like trash cans being left out for too long, home decorations being put up too early, etc. Ultimately this serves to separate individual homeowners from each other and harm the sense of community. I've written about this before; and one of the three readers of this blog has commented on it as well; but, I digress. The problem isn't limited simply to pettiness and over-complaining. These complaints eventually lead to new and more restrictive rules placed on the membership. HOA's often extrapolate from the obscure to the common, and in solving a single, obscure problem, impose general restrictions on everyone regardless of individual situations creating a number of new problems. (All of this reeks of central planning which is, of course, an economic concept but who's shortcomings are equally applicable here.)

The imposition of these rules, I argue, though, has a more insidious and counter-intuitive effect, and that is that people will break the rules simply because they exist. HOA's, in passing rules, assume responsibility for the enforcement of said rules. Normally, a homeowner is obligated to his surrounding neighbors to be "decent" as part of an implied "social contract". When an association explicitly imposes this "decency", the homeowner is now obligated to the HOA (an impersonal, faceless bureaucracy) instead of his immediate neighbors. Suddenly throwing a late night party doesn't inconvenience the neighbors, it breaks association's rules. People are far more likely to transgress against a (perceived) far-away, faceless, emotionless entity than they are the neighbor they have to face each day. Couple this with the decreased sense of community, the knowledge that the inconvenienced neighbor is unlikely to address the situation directly, and the impotence and reticence of HOA's to impose fines; and there is very little incentive to follow the rules.

All of this may sound like an argument for further rules and regulations and more power for HOA's. I think that just the opposite is true, though. That is not to say that problems like late night parties and dogs defecating on lawns should be regular occurrences with which one should have to put up. Rather, with less regulation, the responsibility of homeowners to be decent shifts back to the small, close number of people who are immediately affected by their actions. When neighbors have to deal directly with each other, they begin to empathize with and respect each other as equals instead of railing against a faceless bureaucracy in a far-away place.