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Moral hazard in finance: what is it, what causes it, and what role it played in the recent financial crisis - Essay Example


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Moral hazard in finance: what is it, what causes it, and what role it played in the recent financial crisis

Enhanced roles of government institutions should be geared toward saving countries from the inadequacies and excesses of these institutions, so as to protect the overall standing of the economy (Ile & Lewis, 2013). This paper will examine moral hazard in finance, and what is being done to salvage a dire situation. Moral hazard in finance A moral hazard is a situation whereby one party is largely responsible for the interests of another party, but, unfortunately, the first party has the motivation to put most of their interests first (Ile & Lewis, 2013). The financial system in most regions is marred with situations where one party can take risks that the other party has to fully bear the consequences. One example is a situation where a financial institution can offer members excessive pay out of capital they are managing for other parties. This is just one example, but much more is inevitably happening all around the world. The structure and principles that surround the economic systems around the world are developed or built in a way that they are now responsive to the moral hazards presented in everyday situations (Palley, 2013). Financial crises are occurrences that may rock even the most developed financial institutions, and it is insane to assume that they can be avoided (Palley, 2013). However, the chances of reducing the impact of such occurrences can be increased significantly. Watching out for signs of such times should be the task of government and the financial situations in

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place. It is not enough to come up with policies after the event as the lives of countless individuals hangs in the balance of such actions. Financial systems are fragile. This has prompted institutions to place tougher regulations and requirements to protect the foundations of most economic systems, for example; cash on hand for emergency situations, and loaning to institutions or individuals who are more likely to pay back (Palley, 2013). Causes of moral hazard One of the main causes of moral hazard is risk-taking (Caprio, 2012). Financial institutions around the world believe that they can take risks provided another party has to bear or deal with the consequences afterwards. This makes them operate recklessly taking advantage of situations that would otherwise be considered insane. This is if they were to bear any and all consequences. Control or lack of control of financial moral hazards has led to institutions having these excessive, socially risk-taking tendencies, which culminate in the recurring theme of financial calamities. Countless institutions are pushed by their own propagandas because their money is not on the line, and the return on certain investments is not worth ignoring. This can be placed under the theme of greed on their part. Ponzi schemes where institutions can loan money to individuals, regardless of whether they can pay or not, is as a result of greed. Furthermore, managers in most institutions only look at the short-term period where they have an incentive to cash in on bonuses, even if it means socializing losses while privatizing gains for their own benefit (Caprio, 2012). This is while overlooking long-term effects that they will claim they are not responsible for and that it is not their fault. Since bonuses are not recoverable, they have the ability to cash in on the


Moral Hazard in Finance Name: Institution: Moral Hazard in Finance The policy landscape in economic powerhouses around the world has been dealt a major blow by the financial crisis. Knee-jerk responses have been seen all around these economic powerhouses as policy makers struggle to identify, resolve, and even curb the strain the economic crisis is placing on citizens…
Author : lstokes
Moral hazard in finance: what is it, what causes it, and what role it played in the recent financial crisis essay example
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