Th4.4: ^^ Moral Hazard Flashcards
What is a moral hazard?
when individuals make decisions in their own best interests knowing there are potential risks
It will occur when individual workers take…
adverse risks in order to increase their salary - any problems they cause will be that of the company, not theirs - worst that can happen is they lose their job whereas company could lose millions
How was the Global Financial Crisis caused by a moral hazard?
employees sold mortgages to those who wouldn’t be able to pay them back
By selling more mortgages…
the employees would see higher salaries and bonuses and would not see the negative effects if the loan was not repaid
On top of this, why may financial institutions take excessive risk?
because they know the central bank is the lender of last resort and so will not allow them to fail because of the impact it would have on the economy
