Moral Hazard

Back in 2009, there was a lot of talk about the “moral hazard” of bailing out big financial institutions.  The concern was that, once bailed out, the banks would learn that no matter what happened the Federal Reserve and government would be there to cover all of their bad loans – and thus make more.   In short, providing insurance for default makes it more likely that it will occur.

The term is something like a pop psychology term for the system of socialized risk that defines our entire financial system.

With the benefit of hindsight we can now ask whether or not the bad loans stopped after the big bailouts of 2008.  Did large financial institutions change their behavior and start to behave?  The answer, increasingly, appears to be no, there has been no substantial change in lending behavior since the bailout.  The “moral hazard” appears to be very real – big bets on big risks have continued without much change.  And that’s not only why there is a new crisis but also why serious policy changes must take place.

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