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What risks do moral hazard bring to firms that receive financial help from the government?

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martairobert

Posted February 13, 2013 at 3:08 PM via web

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What risks do moral hazard bring to firms that receive financial help from the government?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted February 13, 2013 at 3:41 PM (Answer #1)

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Moral hazard does not necessarily bring risks to the firms themselves.  It may bring more risk to the government and to society than to the firm.  However, it is possible, depending on what the government does, that the firms will bear risks as well. Moral hazard here may be defined as the possibility that one party will take undue risk and create an economic risk hazard.

When the government bails out a company, it introduces moral hazard.  It creates a situation in which the company does not pay any price for making bad decisions.  The company made bad decisions and yet the government saves it from the consequences of those decisions.  This makes the firm more likely to make risky decisions in the future.  They will think that any “bad bets” they make will be covered by the government.

Of course, this is only a risk to the firm if the government does not bail them out the next time.  If the government does bail them out, it is only the government and the tax payers who have been at risk due to moral hazard.  However, if the government unexpectedly declines to bail them out, they will have to bear the costs of their bad decisions.

Moral hazard means that companies, in this case, are more likely to act in risky ways.  However, the companies may not be the ones who really face the risks.  It could be that the government and taxpayers will be the ones at risk.

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