Friday, February 18, 2011

What Is a Moral Hazard? | The Big Money

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What Is a Moral Hazard? | The Big Money

The economic reasoning behind bailout or no bailout. seems to be the financial term du jour, right behind it is the more ambiguous "moral hazard." Treasury Secretary Henry Paulson moral hazard as the reason not to swoop in to save Lehman Bros. and Merrill Lynch. Puzzling to many, though, was that while moral hazard was discussed in conjunction with the rescues of Bear Stearns, AIG, Fannie Mae, and Freddie Mac, it wasn't a deal breaker in any of those cases. So, what exactly is moral hazard, and why does it matter sometimes more than others? Simply put, moral hazard is the idea that insurance in any form makes people riskier. If I have health insurance, I'm more likely to skydive. If I have fire insurance, I'm more likely to burn sandalwood candles in my bedroom. And if I'm an institutional investor whose holdings are protected by an implicit understanding that the Fed will bail me out if I get in over my head, I'm more likely to double my holdings of subprime mortgage-backed securities rather than cut my losses and pull out when the housing market starts to drop. have a long history. Using them in the context of financial risk is a return to etymological roots; , the Middle Ages precursor to craps, on which bets were placed and fortunes could be swiftly lost. For centuries, the resulting use of the word carried a whiff of the unsavory due to its association with gambling. Martha C. White is a freelance writer in New York. (Dice photo by Michael Connors, Morguefile) Moral Hazard vs Morale Hazard Your use of moral hazard is inaccurate. According to the 2nd edition of Principles of Risk Management and Insurance by the American Institute for Property and Liability Underwriters," a moral hazard is a condition that exists when a person may try intentionally to cause a loss or may exaggerate a loss that has occured. It refers to a defect or weakness in human character that may result in a loss occuring or being enlarged beyond its true value or duration." Your article more accurately describes a "morale hazard" which the 2nd edition of Principles of Risk Management and Insurance states, " is a condition that exists when a person is less careful than he or she should be. Carelessness with property that may increase the probability of a theft loss is an example of a morale hazard." Good job. Now that the market has rallied, we can all relax, right? It's a dark forest out there....

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