The Issue Of Moral Hazard Essay

The Issue Of Moral Hazard Essay

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Moral Hazard is a term that used to describe the situation when a party takes a risky action, even though it knows the action might have bad impact other parties. For example, you do not install smoke dictators, because you have fire insurance; as an insurance agent, you sign a contract with a bad credit policyholder, because you need to meet the sales target for this month. In both cases, you behave inappropriately, while you clearly understand the risks and the potential impacts that come with your action.
There is currently no law that restricts this type of immoral behaviors. The only attribute that prevents people from this is moral, which varies depending on people and highly mercurial. In finance industry, tragedies caused by immoral behaviors led to depressions for the following years. One of the most famous examples is bankrupt of Lehman Brothers Holding Inc in 2008. The driven force of this financial crisis is securitization. Securitization increases the equity of the market because “Securitization is the process through which an issuer creates a financial instrument by combining other financial assets and then marketing different tiers of the repackaged instruments to investors” (Investopedia). The disadvantage of Securitization is moral hazard. In the past, financial organizations would be more conscious in evaluating the credibility of the borrower when they organization issued loans. The reason behind is that they will be not be able to perform assignment of debt to get their money back. The only way to do so is to wait until the borrowers pay back their loans. However, nowadays financial organizations can reassignment the debt to others, which means the risks are also transferred to the people or organization who bu...


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...and started to go downhill, they are no longer able to hit the break. The trophies and valuables became the burden that accelerated the death.
Not everyone can easily go against human nature, greed in this case. Therefore, there are two ways of preventing moral hazard in business industry: incentives or punishment. The root cause of moral hazard is the unbalance in information. The party who holds more information tends to take risks and gain benefits from transactions, while the parties that know less information would usually suffer from the inappropriate act. Making sure the information are balance and transparent to both parties would be an essential act that can somewhat reduce moral hazard. In order to effectively regulate, the legislative branch of government would need to draft law regard to this issue, so that there are “guidelines” for companies to follow.

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