Beware the Moral Hazard

Last year the government bailed out the banking systems and investors by buying more than one trillion dollars in troubled assets. This action caused a lot of concern among economists and regulators who feared that doing so would only encourage investors to make more bad decisions because there were no consequences to taking risks and making bad investment decisions. This is a true example of ‘moral hazard,’ i.e., the encouragement of investors and other individuals to take too much risk because there are no consequences.

An example of this end result is also seen from the government’s stimulus spending under QE2 a few days ago, when poor employment numbers were released, the stock market actually surged in value instead of dropping. Despite the poor data, the market improved because investors know that the government will continue to throw more stimulus money at the problem until it improves.

The unintended consequence of the government trying to solve the problem is actually creating other problems because of the Moral Hazard.