Moral Hazard

While discussing the ramifications of the proposed mortgage bail-outs, SF Mechanist said:

Comment by SF Mechanist
2007-03-31 11:38:59
It’s getting about time that “Moral Hazard” becomes a commonly understood term.

According to Wikipedia:

In economic theory, the term moral hazard refers to the possibility that the redistribution of risk (such as insurance which transfers risk from the insured to the insurer) changes people's behaviour. For example, a person whose automobile is insured against theft may be less vigilant in locking the vehicle than an individual who is not insured...
In economics and ethical theory, the term moral hazard may be used for any situation where a person or organization does not bear the full adverse consequences of its actions...

Rescue operations carried out by governments, central banks, or consortiums of financial institutions can encourage risky lending, if lenders know that in case of serious problems they will not have to take losses. Similarly, if governments know that inability to pay creditors will lead to yet more loans (to prop up finances), then they are less likely to have sound financial policies...

Moral hazard can also refer to questionable lending practices by creditors. In the context of international debt, Jubilee USA argues that the IMF and other international creditors create a "moral hazard" when they "lend irresponsibly in the full knowledge that they will not be held accountable for pushing bad loans. Instead, impoverished countries bear all consequences of ill-advised loans and their repayment." The concept of moral hazard is also closely linked with the concept of odious debt...

In the financial sector, moral hazard has been cited as a potential issue in lending when those with the best knowledge of the risks pass these risks on to third parties, as in the mortgage loan market when securitizing pools of mortgage loans. In the 'traditional' mortgage market, banks and other lenders retained the risk of lending to customers, who were frequently already customers of the same institution. In mortgage securitization, banks 'sell' the loans to investors, and may lose the incentive to maintain the same risk/reward profile and quality standards. This same moral hazard can occur in any lending market where risks are transferred to third parties after origination...

See also

• Perverse incentive, unintended consequence
• Free rider problem, principal-agent problem
• Adverse selection
• Feedback
• Odious debt
• Information asymmetry

Tell your elected officials and local news papers what you think about this. Here's a letter you can use as a draft as well as Congressional contact info; here's another one.