Moral hazard is a situation in which one party engages in risky behaviour or does not act in good faith because it knows that the other party bears the economic consequences of its behaviour. Whenever two parties reach an agreement with each other, moral hazard can arise. Moral hazard has been studied by insurers[27] and scientists; as in the works of Kenneth Arrow,[28][29][30] Tom Baker[31] and John Nyman. While many of the leaders of these companies blamed the poor state of the economy for the financial difficulties their companies were experiencing, in reality, the biggest economic recession simply exposed the risky behaviors they had been practicing for many, many years before the recession began. Borrowers who have struggled to make their mortgage payments have also faced moral hazards when they have decided to try to meet the financial obligation or move away from loans that are harder to repay. As property values plummeted, borrowers found themselves deeper into the water on their loans. The houses were worth less than the amount owed for the mortgages associated with them. Some homeowners may have seen this as an incentive to leave, as their financial burden would be reduced by abandoning a property. These bailouts, carried out at the expense of taxpayers, represented a situation of enormous moral hazard; The government`s drive to bail out its businesses sent a message to the leaders of big business that all the economic costs of too risky business activities (to increase their profits) would be borne by someone other than themselves. The problem with disinformation or disparate information is that the two sides are not on the same page.

Such a problem is dangerous in any business situation, but especially with regard to the conclusion of insurance. The party taking out insurance intends to act in a way that benefits them the most, knowing that the insurance covers all the risks taken. The information is usually not shared with the insurance company, as this would usually result in higher premium requirements or an inability to obtain the insurance policy. In the end, the U.S. government felt that these companies were too big to go bankrupt and came to their aid in the form of a bailout. This bailout cost taxpayers hundreds of billions of dollars; The U.S. government`s reasoning was that the bankruptcy of companies so critical to the status quo of the country`s economy could plunge the U.S. into a deeper economic depression from which it ultimately could not recover.

Moral hazard is a problem for insurance companies, as the relaxed attitude of insured customers usually leads insurance companies to pay more insurance claims. It is widely believed that as a result of this chain of events, many banks in the United States, according to the U.S. Federal Deposit Insurance Corporation, there were 6,799 FDIC-insured commercial banks in the U.S. as of February 2014. feel that if they ever go through a difficult time, the government will be there to save them. This leads to a situation of moral hazard because instead of taking effective measures to prevent overexposure in the future, banks are more likely to continue to make risky loans if they provide temporary gains that are beneficial to them. The method of remunerating the remuneration of certain sellers is another situation in which moral hazard is more likely to occur. If a business owner pays a salesperson a fixed salary – not based on their performance or sales figures – that salesperson may be incentivized to put in less effort, take longer breaks, and generally have less motivation to increase sales than if their compensation was tied to their sales numbers. The problem with moral hazard is when a party in a business or transaction is more comfortable taking risks, whether physical or financial, because they know they are not responsible for the negative consequences, but the party that does not take the risks. There are many cases concerning the problem of moral hazard in the insurance market.

A notable example is auto insurance in New Jersey. In the 1980s, New Jersey was considered the worst problem in auto insurance. There was no cap on the medical expenses that could be claimed from each accident, and the state even offered car insurance, Joint Underwriting Authority (JUA), for drivers who are too risky to get insurance from private companies at a similar rate for less risky drivers. The State suffered a significant loss of its insurance policy. The traffic accident rate and car theft rate were much higher than in most other states. Drivers engaged in riskier behavior when insured against medical treatment and car theft. The JUA had accumulated a $3 billion deficit by the late 1980s, and additional taxes were needed to cover the loss that posed a major problem for the government. A second type of behavior that can change is to respond to the negative consequences of risk once they have occurred and insurance is provided to cover their costs.

This can be called ex post moral hazard (after the event). Policyholders then do not behave in a riskier way, which leads to more negative consequences, but they ask an insurer to pay for more negative consequences of the risk if insurance coverage increases. For example, some without health insurance may forego medical treatment because of their cost and simply cope with inferior health. However, once health insurance is available, some may ask an insurer to cover the cost of medical treatment that otherwise would not have taken place. The secondary part is the one that suffers all the consequences of all the risks taken in a situation of moral hazard, so that the first part can freely do what it wants, without fear of responsibility. They are able to ignore all moral implications and act in the way that is most beneficial to them. Many academics and journalists have argued that moral hazard played a role in the 2008 financial crisis, as many financial market participants may have been incentivized to increase their exposure to risk. [21] [22] In general, there are three ways in which moral hazard may have manifested itself in the run-up to the financial crisis.

The Dodd-Frank Act of 2010 aimed to reduce the likelihood of additional moral hazard for these “too big to fail” companies. The law required these companies to draw up specific plans for the future in advance if they again encountered financial difficulties. The law also stipulated that these companies would no longer be saved at the expense of taxpayers in the future. In the financial and banking sector, moral hazard can also be found in various cases. Speculative investment banking activities are guaranteed by the government because their failure will affect the entire economy. .