Moral Hazard in Light of 2007-2008 Crisis
I. Introduction
Financial crises had repeated several times such as the great depression in 1920, saving and loan crisis in 1986 and Asian crisis in 1997 before the 2007-08 financial crisis. There are a considerable number of articles about the causes of financial crises. Based on the traditional view, the causes of the financial crisis are the government budget imbalances, high inflation, low investment, low savings and low growth rate (Esquivel and Larrain, 1998). Specifically, the causes for the 2007-08 financial crisis stemmed from house price bubbles, the failure of risk management at sub-prime mortgage market and the dysfunctional ranking system and the causes are implicit in the relationship with a moral hazard. The definition of moral hazard is based on Leopold’s description (2009, p. 48): “More insurance could lead to lazier bicycle riders – a moral hazard – who enable more bicycle thefts. In finance the bicycle is risk. If I know I will be bailed out if I assume risk and fail, I’ll assume more and more risk and let you bail me out if I fail”. It mainly arises due to information asymmetry; asymmetric information is the situation in which one party in an economic transaction has better information than the other party.
Thus, in this essay, we will discuss whether the solution to a moral hazard problem is to eliminate asymmetry in the information that a borrower and a lender had in light of the financial crisis. It is structured with three parts, First we will provide evidence for the relationship between asymmetric information and a moral hazard problem; Second we will discuss other reasons causing moral hazard problems, particularly in the intervention of governments. Finally a brief summary of the discussion and the conclusion will be given.
II. The relationship between asymmetric information and a moral hazard problem
Complete information describes a condition when individuals involved could access all relevant information, and complete
Financial crises had repeated several times such as the great depression in 1920, saving and loan crisis in 1986 and Asian crisis in 1997 before the 2007-08 financial crisis. There are a considerable number of articles about the causes of financial crises. Based on the traditional view, the causes of the financial crisis are the government budget imbalances, high inflation, low investment, low savings and low growth rate (Esquivel and Larrain, 1998). Specifically, the causes for the 2007-08 financial crisis stemmed from house price bubbles, the failure of risk management at sub-prime mortgage market and the dysfunctional ranking system and the causes are implicit in the relationship with a moral hazard. The definition of moral hazard is based on Leopold’s description (2009, p. 48): “More insurance could lead to lazier bicycle riders – a moral hazard – who enable more bicycle thefts. In finance the bicycle is risk. If I know I will be bailed out if I assume risk and fail, I’ll assume more and more risk and let you bail me out if I fail”. It mainly arises due to information asymmetry; asymmetric information is the situation in which one party in an economic transaction has better information than the other party.
Thus, in this essay, we will discuss whether the solution to a moral hazard problem is to eliminate asymmetry in the information that a borrower and a lender had in light of the financial crisis. It is structured with three parts, First we will provide evidence for the relationship between asymmetric information and a moral hazard problem; Second we will discuss other reasons causing moral hazard problems, particularly in the intervention of governments. Finally a brief summary of the discussion and the conclusion will be given.
II. The relationship between asymmetric information and a moral hazard problem
Complete information describes a condition when individuals involved could access all relevant information, and complete