Moral Hazard

People engage in activities described as being subject to moral hazard when they take excessive risk on the basis that – and only because – someone else will be liable for the potential losses. Banks taking excessive trading or lending risk on the assumption they would be bailed out by governments if the worst came to the worst is an example of moral hazard. It is the notion of too big to fail given the systemic risk of bank failure; of profits being privatised while losses are socialised (i.e. covered by taxpayers). Banks making poor lending decisions but passing on default risk to third parties by repackaging or reselling the risk, is another example. Some argue that deposit insurance schemes whereby governments bail out retail depositors up to certain deposit ceilings create moral hazard risk.