moral hazards in financial system
Moral Hazard and Asymmetric Information in the Financial System
Subprime Loans and the Housing Bubble Burst A moral hazard in economics is where someone takes a risk that they wouldn't normally take because they know that the consequences of that risk not paying off will be paid by somebody else. The case we will be discussing will be the housing bubble burst and it relates to the topic because lenders took great risks lending money to people that could not afford it knowing their banks were too big to fail and the government would have to bail them out. To begin this case we must first give a brief summary. After the dot-com bubble burst of 2000 and the attacks on the US on September 11 the US economy was at a great risk of going into a recession. Central banks around the world including our federal reserve tried to stimulate the economy by reducing interest rates. This made a lot of people see the opportunity to make money and they started taking on riskier investments like for example buying houses that they knew they couldn't afford hoping to flip it in a couple of years and make a great deal of money. Lenders saw this as an opportunity to make money as well by lending all this money but they did it with high risk approving people with subprime credit that would normally never get approved for these loans. Consumers kept this trend going and every year more and more subprime mortgages were being initiated until 2006 when the housing bubble finally burst. The result was more foreclosures per year than had ever been seen before in the US and many lenders and hedge funds having to declare bankruptcy or need government bail outs.
Subprime Loans and the Housing Bubble Burst A moral hazard in economics is where someone takes a risk that they wouldn't normally take because they know that the consequences of that risk not paying off will be paid by somebody else. The case we will be discussing will be the housing bubble burst and it relates to the topic because lenders took great risks lending money to people that could not afford it knowing their banks were too big to fail and the government would have to bail them out. To begin this case we must first give a brief summary. After the dot-com bubble burst of 2000 and the attacks on the US on September 11 the US economy was at a great risk of going into a recession. Central banks around the world including our federal reserve tried to stimulate the economy by reducing interest rates. This made a lot of people see the opportunity to make money and they started taking on riskier investments like for example buying houses that they knew they couldn't afford hoping to flip it in a couple of years and make a great deal of money. Lenders saw this as an opportunity to make money as well by lending all this money but they did it with high risk approving people with subprime credit that would normally never get approved for these loans. Consumers kept this trend going and every year more and more subprime mortgages were being initiated until 2006 when the housing bubble finally burst. The result was more foreclosures per year than had ever been seen before in the US and many lenders and hedge funds having to declare bankruptcy or need government bail outs.