Too Embarrassed To Ask: what is moral hazard?

Too Embarrassed To Ask: what is moral hazard?

i wish i knew what moral hazard was but i'm too embarrassed to ask the term moral hazard was first widely used in the insurance industry in the 18th century put simply it refers to a situation in which a person or institution engaged in a risky activity does not bear the full negative consequences of their decisions this lack of consequences encourages them to behave more recklessly than if they were fully responsible for their actions here's an easy example let's say you've insured your mobile phone as a result you don't bother to buy a protective case for it after all if it drops on the floor and breaks the insurer will pay that's moral hazard for a much more dramatic real-life example consider the role moral hazard played in the financial crisis of 2008. in the early 2000s the u.s housing market was booming investors lined up to buy bundles of u.s mortgages which they saw as a low-risk way to get higher interest payments than they could get from u.s government bonds they bought these mortgage bundles from the banks the banks in turn made the bundles out of individual mortgages they'd bought from mortgage lenders because there was so much demand mortgage lenders paid their sales people big bonuses to sell as many mortgages as they could but because they were immediately selling the mortgages onto the banks the mortgage lenders didn't worry about how creditworthy the borrowers were they just cared about their commissions and because the banks were selling the mortgage bundles onto investors they didn't worry about the quality of the loans they just cared about their fees in short the people who issued the mortgages made a profit and thought they had offloaded the risks to someone else then house prices fell some home owners stopped paying their loans and the entire financial system nearly collapsed that's moral hazard too when profits go to one group of individuals or companies but losses are borne by the taxpayer as a group and moral hazard is still right in the financial system for example central banks constantly step in and print money to prevent economic shocks from spreading but that encourages investors to take more risk than they otherwise would which just sets us up for a worse crash in the future on that cheery note may i suggest you subscribe to moneyweek magazine [Music]


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