Essay about Moral Hazard

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The theme of moral hazard comes up numerous times throughout the movie, Too Big To Fail and is an extremely important factor when considering what happened in September of 2007 and its consequences. By definition, moral hazard is, “the risk that a party to a transaction has not entered into the contract in good faith, has provided misleading information about its assets, liabilities or credit capacity, or has an incentive to take unusual risks in a desperate attempt to earn a profit before the contract settles” (Investopedia). Basically it’s when others such as these investment banks are careless with the money invested by the people because it isn’t their money or their risk. This was the case throughout many points in the film. First, …show more content…

Ultimately, U.S Treasury Secretary Henry Paulson directed CEO of Lehman Brothers, Dick Fuld to declare bankruptcy before the market opened. They decided against bailing them out and preached to the public about moral hazard. In this situation, if they were to bail Lehman Brothers out, it would promote the theory that, it wouldn’t matter if banks are careless with others money if they are going to get bailed out anyway, and also what is stopping these banks from not repeating the same mistake if the Fed bails them out in the end. This came over well initially in the public for those exact reasons but soon turned. Because of Lehman Brothers counterparty risk, it affected the entire financial market and another giant, AIG, began to collapse. With AIG failing it would cause the entire financial system to fall and cause massive problems. Due to these reasons Paulson lobbied for the government to intervene and eventually they did and passed the Emergency Economic Stabilization Act of 2008, which allowed Paulson to spend up to 700 billion to purchase securities and inject cash directly into banks. They ended up doing exactly what they weren’t willing to with Lehman Brothers and their preaching against moral hazard went right out the window when they decided to bail out AIG. Moral Hazard is a double edged sword because in the end, what is to stop these banks from doing the same thing again? Also, if

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