Editing Moral hazard (section)

===Connection to the 2008 financial crisis===
{{Main|2008 financial crisis}}

Many scholars and journalists have argued that moral hazard played a role in the [[2008 financial crisis]], since numerous actors in the financial market may have had an incentive to increase their exposure to risk.<ref name=":1">{{Cite journal|last=Okamoto|first=Karl|date=2009|title=After the Bailout: Regulating Systemic Moral Hazard|url=https://www.uclalawreview.org/pdf/57-1-4.pdf|journal=UCLA Law Review|pages=183–236|url-status=live|access-date=2021-06-01|archive-url=https://web.archive.org/web/20201130100922/https://www.uclalawreview.org/pdf/57-1-4.pdf|archive-date=2020-11-30}}</ref><ref name=":2">{{Cite web|url=https://www.investopedia.com/ask/answers/050515/how-did-moral-hazard-contribute-financial-crisis-2008.asp|title=How did moral hazard contribute to the 2008 financial crisis?|last=Investopedia|website=Investopedia|language=en|access-date=2020-03-02|date=2019-06-25|url-status=bot: unknown|archive-date=March 2, 2020|archive-url=https://web.archive.org/web/20200302061627/https://www.investopedia.com/ask/answers/050515/how-did-moral-hazard-contribute-financial-crisis-2008.asp}}</ref> In general, there are three ways in which moral hazard may have manifested itself in the lead up to the financial crisis:

* Asset managers may have had an incentive to take on more risk when managing other people's money, particularly if they were paid as a percentage of the fund's profits. If they took on more risk, they could expect higher payoff for themselves and were somewhat shielded from losses because they were spending other people's money.<ref name=":1" /> Therefore, asset managers may have been in a situation of moral hazard, where they would take on more risk than appropriate for a given client because they did not bear the cost of failure.
* Mortgage loan originators, such as [[Washington Mutual]], may have had an incentive to understate the risk of loans they originated because the loans were often sold to mortgage pools (see [[Mortgage-backed security|mortgage-backed securities]]). Because loan originators were paid on a per-mortgage basis, they had an incentive to produce as many mortgages as possible, even if they were risky.<ref name=":1" /> Because these institutions did not expect to hold on to the loans until maturity, they could pass on the risk to the buyer of the loans.<ref name=":2" /> Therefore, mortgage loan originators may have been in a situation of moral hazard, because they did not bear the costs of the risky mortgages they were underwriting.
* Third, large banks may have believed they were "[[too big to fail]]." That is, because these banks were so ingrained in the US economy, the federal government would not have allowed them to fail in order to prevent a full-scale economic crash. This belief may have been shaped by the 1998 bailout of [[Long-Term Capital Management]].<ref name="nyt080907" /> "Too big to fail" banks may have believed they were essentially invincible to failure, thus putting them in a position of moral hazard: they could take on big risks&nbsp;– thus increasing their expected payoff&nbsp;– thinking that the federal government would bail them out in the event of a major failure. Therefore, large banks may have been in a situation of moral hazard, because they did not bear the costs of a catastrophic collapse.

Notably, the [[Financial Crisis Inquiry Commission]] (FCIC), tasked by Congress with investigating the causes of the financial crisis, cited moral hazard as a component of the crisis, arguing that many factors, including deregulation in the derivatives market in 2000, reduced federal oversight, and the potential for government bailout of "too big to fail" institutions all played a role in increasing moral hazard in the years leading up to the collapse.<ref name=":5">{{Cite report|url=https://www.govinfo.gov/content/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf|title=The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States|author=National Commission on the Causes of the Financial and Economic Crisis in the United States|date=February 25, 2011|url-status=live|archive-url=https://web.archive.org/web/20181216095833/https://www.govinfo.gov/content/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf|archive-date=2018-12-16}}</ref>

Others have argued that moral hazard could not have played a role in the financial crisis for three main reasons. First, in the event of a catastrophic failure, a government bailout would only come after major losses for the company.<ref name=":3">{{Cite magazine|url=https://www.newyorker.com/business/james-surowiecki/moral-hazard-and-the-crisis|title=Moral Hazard and the Crisis|last=Surowiecki|first=James|magazine=The New Yorker|date=January 14, 2010|language=en|access-date=2020-03-02|url-status=bot: unknown|archive-date=October 24, 2020|archive-url=https://web.archive.org/web/20201024072130/https://www.newyorker.com/business/james-surowiecki/moral-hazard-and-the-crisis}}</ref> So even if a bailout was expected it would not prevent the firm from taking losses. Second, there is some evidence that big banks were not expecting the crisis and thus were not expecting government bailouts, though the FCIC tried hard to contest this idea.<ref name=":3" /> Third, some have argued that negative [[Externality|externalities]] from corporate governance were a more important cause, since some risky investments may have had positive expected payoff for the firm but negative expected payoff to society.<ref name=":4">{{Cite journal|last=Schwarcz|first=Steven L.|date=December 2017|title=Too Big to Fool: Moral Hazard, Bailouts, and Corporate Responsibility|url=https://scholarship.law.umn.edu/cgi/viewcontent.cgi?article=1093&context=mlr|format=PDF|archive-format=PDF|journal=Minnesota Law Review|volume=102|pages=761–802|access-date=2021-06-01|archive-url=https://web.archive.org/web/20200318122717/https://scholarship.law.umn.edu/cgi/viewcontent.cgi?article=1093&context=mlr|archive-date=2020-03-18|url-status=live}}</ref>