I was recently asked:
In light of Hurricane Charley, do you think offering disaster relief funds to people who lived on sand is wrong?
Tricky. On the one hand - no, of course, they shouldn't be offered disaster relief funds. Play with fire, get burnt. If you do help people out when they do something stupid, what your really going to do is ensure they do a whole lot more of that stupid behaviour in the future because they don't face the penalties. If someone realises they can build in a beautiful area with low property prices (but occasional storms that wipe their house out), but that someone else will pay to rebuild their house, then of course they'll build there. And all their friends too...
On the other hand... One of the major functions of governments is to bail people out when they do stupid things. Fire departments put out fires which people were silly enough to start, FDIC ensures deposits when people were stupid enough to put them in dodgy banks, welfare provides money to people who were incompetent enough to lose there jobs... All of these things, to some extent or another, encourage more of the activities they make less painful.
The economics term for this is "moral hazard", and one place its a very big problem is in emerging markets. People often buy very high risk (but very high yield) securities from emerging markets (ie, third world banana republics with unstable governments). Mostly they make a whole lot of cash - but now and again the country had some sort of disaster, or a revolution, or whatever, and defaults, at which point these (mainly wealthy, market-savvy) investors start screaming for a bailout from the IMF, World Bank, etc.
If they always get bailed out (and, generally, they do), then there really isn't any risk after all - but the yields are still high, and the obvious rational response is for a whole lot more people to pile into emerging markets - including non-wealthy non-market-savvy investors. Soon, bailing them out becomes very difficult and expensive, yet at the same time, many of the people involved didn't have the slightest idea what risks they were running when they dumped their pension funds into Bolivian bonds, or whatever.
Whats the answer? There isn't one single answer. In general, if people know the risks they're running, then the risk of disaster should be "priced into" the activity. The reason real estate is cheap on islands that get hit by hurricanes is because they get hit by hurricanes. The reason debt from unstable countries pays a high rate of interest is because the countries are unstable. There's no need to reward people twice for doing something risky - they already got rewarded by the price, or they wouldn't have been there to start with. On the other hand, its very difficult (and, perhaps, immoral) to stand by while people who didn't have a clue what they were doing get wiped out.
But where do you draw the line? Hard to say.
This is, incidentally, a similar sort of issue as which pops up with fast food. Again, one approach would be to say that people are smart, they can work out what diet they wish to follow, and more power to them - and if that diet consists solely of Big Macs, well, its their life (and a short life it may prove to be). Of course, if they know the taxpayer will pay for their eventual health care needs, its not entirely "their life" then, is it? In which case perhaps we should control their life to make them more responsible, eliminate the health care to make it their responsibility, or perhaps, just shrug and accept it as a cost of doing business. (Of course, it may be too high a cost for society to afford. The jury is still out.)
Come to that, some very similar calculations are involved with recreational drugs...