Moral Hazard in Finance - Essay Example

Moral hazard, in some, if not all quarters, has been the story most people blame for the financial crisis as greedy bankers and institutions run away with billions of taxpayers’ money. It is the failure to monitor and control financial institutions by governments that have resulted in the financial meltdown that has seen most economies around the world suffer. 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 hazards 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 payout 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 the government and the financial situations in place. It is not enough to come up with policies after the event as the lives of countless individuals hang 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 afterward. 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, are 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 short-term period ignoring the fact that their backers might suffer. This is what leads to the conclusion that institutions refuse to acknowledge the need for a more accountable long-term view, which also means that the moral hazard in the financial field is out of control.

The role played by moral hazard in the financial crisis
In the financial crisis that rocked the globe, financial institutions engaged in reckless and unwarranted behavior. This is because they thought that the government would be there to bail them out of their predicament. Too many institutions, it is alright if the prices of their shares are down to nothing provided the government will automatically swoop in and salvage the situation. Read More