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Moral Hazard In The 2008 Financial Crisis

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Moral hazard in the 2008 financial crisis In the build-up to the financial crisis, the relaxed conditions set on loans and credit provided in the U.S created a moral hazard as the lending was unsustainable, and became a high risk with the likely possibility of borrowers defaulting on mortgage repayment loans alongside unrealistic housing valuations (Mian and Sufi, 2009: 1453). The correlation between foreign investment, low interest rate set by the Federal Reserve to avoid a recession after the failing technology stock bubble, and the desire for securities, contributed to the financial crisis of 1997-8 as well as to the U.S trade deficit (Allen and Carletti, 2010:2). This created a moral hazard as the investment from east Asian funds created …show more content…

Confidence and investment was produced by authorising loans in the U.S economy (Allen and Carletti, 2010: 5), however the inability of mortgage holders to keep up with payments resulted in the entire state facing the moral hazard of a broken economy (Gorton, 2012: 10). Therefore, moral hazard in the build-up to the 2008 financial crisis was the result of manipulations and malpractice, all of which led to unrealistic expectations for economic performance (Mian and Sufi, 2009: …show more content…

For this reason, the government faced the burden of moral hazard as the risky decisions made by financial institutions from 2004-2008 were paid for by national governments, through taxpayers (Barth and Wihlborg, 2016, 27). Furthermore, there was also a moral hazard caused by the Federal Reserve who made reckless and ill-thought decisions including the provision of low interest rates and cheap credit. This was the only way financial institutions could offer mortgages to ill-equipped borrowers who wouldn’t usually have met the conditions for responsible and sustainable loans (Samwick, 2009:

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If there was ever a word to describe the events that led up to the financial crisis of ’08, “Moral Hazard” would fit the bill perfectly. Moral hazard happens in financial terms when the success of a particular transaction is very heavily dependent on the performance of a particular party’s obligations, but where a particular party has no interest or incentive to carry out that obligation diligently. Let’s for instance take the example of a loan worth $720K, which was given to a strawberry picker earning around$14K/year to acquire a certain piece of property in the early 2000’s . In this case moral hazard was there and existed because the loan company intended to sell the loan forward to the credit rating agencies due to the inability of the

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While the lenders get their money without having to inflate prices. Also, financial corruption from banks and wall street had influenced the creation of The Great Recession. There was predatory lending in the mortgage markets and banks had knowingly loaned millions of checks on mortgages . This led to a tremendous Economic crash as stated in (document e ).

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At one time Greenspan was hailed the greatest central banker in history, after the 2008 crash, everybody blamed him for the country’s distress. In 2000, Greenspan raised interest rates several times; these actions were believed by many to have caused the bursting of the dot-com bubble. Krugman exclaims, “Greenspan didn't raise interest rates to curb the market's enthusiasm; he didn't even seek to impose margin requirements on stock market investors. Instead, he waited until the bubble burst, as it did in 2000, and then tried to clean up the mess afterward”. The Economist (2010) also considers that cheap money led to the wholesale underpricing of risks.

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