In an economy, moral hazard occurs when a person increases their exposure to risk when insured. This can happen, for example, when someone takes more risks because other people bear the cost of those risks. Moral hazards can occur when one party's actions can change to the detriment of the other after a financial transaction takes place.
A party makes decisions about how much risk should be taken, while others bear the costs if things get worse, and those isolated from risk behave differently from what if it is fully exposed to risk.
Moral hazards can occur under the type of information asymmetry in which risk-taking parties know more about their intentions than those who pay for the consequences of risk. More broadly, moral hazard can occur when parties with more information about their actions or intentions have a tendency or inclination to behave inappropriately from a party perspective with less information.
Moral hazards also arise in the principal-agent problem, in which one party, called the agent, acts on behalf of the other, the so-called principal. Agents usually have more information about their actions or intentions than principals do, because principals can not normally fully monitor the agency. The agent may have an incentive to act inappropriately (from a principal point of view) if the interests of the agent and principal are out of alignment.
Video Moral hazard
Contoh
For example, in relation to subprime lenders, many may suspect that borrowers will not be able to keep their payments in the long run and that, for this reason, loans will not be worth much. However, since there are many buyers of this loan (or collection of loans) willing to take that risk, the originator does not concern himself with the potential long-term consequences of making this loan. After selling the loan, the originator assumes no risk so there is no incentive for the originator to investigate the long-term value of the loan.
Maps Moral hazard
History of the term
According to research by Dembe and Boden, this term originated in the 17th century and was widely used by British insurance companies in the late 19th century. The initial use of the term contains negative connotations, implying fraud or immoral behavior (usually on the insured side). Dembe and Boden show, however, that the leading mathematician who studied decision making in the 18th century used "moral" to mean "subjective", which could obscure the true ethical meaning in the term. The concept of moral hazard is the subject of renewed study by economists in the 1960s and then does not imply immoral behavior or fraud. Economists will use this term to describe the inefficiencies that can occur when the risk of displacement or not can be fully evaluated, rather than the ethical or moral descriptions of the parties involved.
Rowell and Connelly offer a detailed explanation of the origin of the term moral dangers, identifying important changes in economic thought, identified in theological literature and medieval probabilities. Their paper compares and contrasts the normative dominant moral hazard found in the insurance industry's literature with the most positive interpretation found in the economic literature. Often what is described as "moral hazard [s]" in the insurance literature is after a closer reading, the description of the concept is closely related, reverse selection.
Finance
Economist Paul Krugman describes the moral dangers as "any situation where one person makes a decision about how much risk should be taken, while others bear the cost if things get worse." Bailouts of financial lending institutions by governments, central banks, or other agencies may encourage future risky lending if those at risk believe that they do not have to bear the full burden of potential losses. Lending institutions need to take risks by lending, and usually most risky loans have the potential to generate the highest returns.
Taxpayers, depositors, and other creditors often have to bear at least some of the burden of risky financial decisions made by lending institutions.
Many argue that some types of mortgage securitization contribute to moral hazard. Mortgage securitization allows mortgage initiators to convey the risk that their mortgages can default and do not withhold mortgages on their balance sheets and bear the risks. In one type of mortgage securitization, known as a "securitization agent," the default risk is maintained by the securities agent who buys the mortgage from the originator. These institutions have an incentive to monitor originators and check the quality of loans. "Agent Securitizations" refers to the securitization by Ginnie Mae, a government agency, or by Fannie Mae and Freddie Mac, a government-sponsored profit-oriented company ("GSE"). They are similar to "closed bonds" commonly used in Western Europe because securities firms maintain a default risk. Under both models, investors only take interest rate risk, not risk default.
In other types of securitization, known as "private label" securitization, the default risk is generally not kept by the securitization entity. In contrast, the securitization entity poses a default risk to investors. The securitization entity, therefore, has relatively little incentive to monitor the originator and maintain the quality of the loan. "Private label" securitization refers to the securitization structured by financial institutions such as investment banks, commercial banks, and non-bank mortgage lenders.
During the years leading up to the subprime mortgage financial crisis, private label securitization grew as part of overall mortgage securitization by buying and securing high-quality, high-risk mortgage securities. The securitization agency seems to have somewhat lowered their standards, but institutional mortgages remain much safer than mortgages in private label securitization, and perform much better in terms of default rates.
Mark Zandi's economist from Moody's Analytics describes the moral hazard as the root cause of the subprime mortgage crisis. He writes that "the inherent risks to mortgage lending are so widespread that nobody is forced to worry about the quality of a single loan, because faltering mortgages are combined, reducing problems into larger pools, incentives for undervalued responsibilities." wrote: "Financial companies are not subject to the same regulatory oversight as banks.The taxpayers are not ready if they go up [pre-crisis], only the shareholders and other creditors.The financial companies have little to prevent them from growing as aggressively as possible , even if it means lowering or blinking on traditional lending standards. "
Moral hazards can also occur to the borrower. The borrower may not act cautiously (in the lender's view) when they invest or spend money carelessly. For example, credit card companies often limit the number of borrowers who can spend it with their cards because without such restrictions, the borrower may spend indiscriminate loan funds, leading to a default.
The mortgage securitization in America began in 1983 at Salomon Brothers and where the risk of each mortgage is passed on to the next buyer and not left in the original mortgage institution. These mortgages and other debt instruments are put into a large collection of debt, and then shares in the pool are sold to many creditors.
Thus, no person is responsible for verifying that there is one particular healthy loan, that the asset that guarantees that one particular loan is worth what it should be worth, that the borrower responsible for making the loan payments can read and write the language used by the letter - the letter he signed, or even the document was there and in good working order. It has been suggested that this may have caused a subprime mortgage crisis.
Brokers, who do not lend their own money, push the risk to the lender. The lender, who sold the mortgage immediately after conducting underwriting, pushed the risk to investors. Investment banks buy mortgages and liquefy mortgage-backed securities into slices, some more risky than others. Investors buy securities and hedge against default risks and upfront payments, pushing the risk further. In a purely capitalist scenario, the latter holding the risk (like a music chair game) is a person who faces potential losses. However, in a sub-prime crisis, the national credit authority (Federal Reserve in the US) bears the last risk on behalf of the people as a whole.
Others believe that the financial bailouts of lending institutions do not encourage risky lending behavior because there is no guarantee for lending institutions that a bailout will happen. A decrease in corporate valuation before a bailout will prevent risky and speculative business decisions by executives who conduct due diligence in their business transactions. The risks and burdens of losses are made clear to Lehman Brothers (which does not benefit from the bailout) and other financial institutions and mortgage companies such as Citibank and Countrywide Financial Corporation, whose valuations fall during the subprime mortgage crisis.
Insurance industry
Its name comes from the insurance industry. Insurance companies worry that protecting their clients from risks (such as fire, or car accidents) may encourage such clients to behave in a more risky way (such as smoking in bed or not using seat belts). This problem can inefficiently make these companies not protect their clients as much as clients want to protect.
Economists argue that this inefficiency results from information asymmetry. If insurance companies can perfectly observe the actions of their clients, they may refuse coverage for clients who choose risky measures (such as smoking in bed or not wearing seatbelts), allowing them to provide overall protection against risk (fire, accidents) without encouraging behavior risky.. However, since insurance companies can not perfectly observe the actions of their clients, they are not advised to provide the amount of protection to be provided in a world with perfect information.
Economists distinguish the moral hazard from inverted selection, another problem that arises in the insurance industry, caused by hidden information rather than by hidden actions .
The same underlying problem of actions that can not be observed also affects other contexts other than the insurance industry. It also appears in banking and finance: if a financial institution knows that it is protected by the lender of last resort, it can make riskier investments than if there is no protection.
In the insurance market, moral hazard occurs when the insured party's behavior changes in a way that increases the cost to the insurer, because the insured party no longer bears the full cost of that behavior. Because individuals no longer bear the cost of medical services, they have an additional incentive to ask for more expensive and more complicated medical services, which otherwise are not necessary. In this case, individuals have an incentive to consume excessively, simply because they no longer bear the full cost of medical services.
Two types of behavior can change. One of its kind is the risky behavior itself, which results in moral hazard before the event . In this case, the insured parties behave in a more risky manner, resulting in more negative consequences to be paid by the insurance company. For example, after purchasing car insurance, some may tend to be less cautious in locking the car or choosing to drive more, thus increasing the risk of theft or accidents for insurance companies. After purchasing fire insurance, some people may tend to be less careful about preventing fire (eg, smoking in bed or neglecting to replace the battery in a fire alarm). A further example has been identified in flood risk management where it is proposed that insurance owners undermine efforts to encourage people to integrate flood protection and resilience measures in flood-affected properties.
A second type of behavior that may change is a reaction to the negative consequences of risk, once it arises and once insurance is provided to cover its costs. This can be called ex post (after the event) moral hazard. In this case, the insured party does not behave in a more risky manner that results in more negative consequences, but they ask the insurer to pay more for the negative consequences of the risks as insurance coverage increases. For example, without health insurance, some may cancel medical treatment because of the cost and only deal with substandard health. But after health insurance is available, some may ask the insurer to pay for medical treatment costs that will not be otherwise.
Sometimes moral dangers are so severe that making insurance policies impossible. Coinsurance, joint payments, and deductibles reduce the risk of moral hazard by increasing consuming consumer spending, which reduces their incentive to consume. Thus, the insured has financial incentives to avoid making claims.
The moral dangers have been studied by insurance companies and academics; as in the works of Kenneth Arrow, Tom Baker, and John Nyman.
John Nyman suggests that there are two types of moral hazards: an efficient and inefficient moral hazard. An efficient moral hazard is the point of view that too much consumption of medical care brought by insurance does not always result in welfare losses to society. Instead, individuals achieve better health through increased consumption of medical care, making them more productive and overall net benefits for the welfare of society. Also, Nyman points out that individuals buy insurance to earn income transfers when they become ill, as opposed to the traditionalist attitude that individuals diversify risk through insurance.
Economic theory
In economic theory, moral hazard is a situation where the behavior of one party may change to the detriment of the other after the transaction takes place. For example, a person with insurance against auto theft may be less cautious about locking up their car because of the negative consequences of vehicle theft now (in part) the responsibility of the insurance company. A party makes decisions about how much risk should be taken, while others bear the cost if things get worse, and those who are isolated from risk behave differently than if they are fully at risk.
According to contract theory, moral hazard results from situations where hidden action occurs. Bengt HolmstrÃÆ'¶m says this:
It has long been recognized that moral hazard issues can arise when individuals engage in risk-sharing in conditions such as actions taken personally affect the probability distribution of results.
The moral danger can be divided into two types when it involves asymmetric information (or lack of certainty) of the results of random events. The moral dangers of ex-ante are behavioral changes before the outcome of random events, whereas ex-post involves behavior after the outcome. For example, in the case of a health insurance company that insured a person for a certain period of time, the individual's final health could be considered as a result. Individuals who take a greater risk during that period would be an ex-ante moral hazard while lying about fictitious health problems to deceive insurance companies would be a morality hazard. The second example is the case of a bank that provides loans to an entrepreneur for a risky business venture. Entrepreneurs become too risky to be an ex-ante moral dangers, but a deliberate failure (incorrectly claiming that the business fails when profitable) is a post-ex moral danger.
According to Hart and HolmstrÃÆ'¶m (1987), the moral hazard model can be divided into models with hidden actions and models with hidden information. In the previous case, once the contract is signed, the agent chooses an action (eg level of effort) that the principal can not observe. In the latter case, after the contract is signed, there is a random lottery that determines the type of agent (for example, his valuation for goods or business expenses). In the literature, two reasons have been discussed why moral dangers can imply that the first best solution (ie, a solution to be achieved with complete information) is not achieved. First, agents may avoid risk, so there is a trade-off between providing agents with incentives and insuring agents. Second, the agent may be risk neutral but constrained by wealth, so the agent can not make payments to the principal and there is a trade-off between providing incentives and minimizing the agency's limited liability rent. Among the initial contributors to the theoretical contractual literature on moral dangers are Oliver Hart and Sanford J. Grossman. Meanwhile, the moral hazard model has been extended to cases of multiple periods and many tasks, both with risk-averse and risk-neutral agents. There are also models that combine hidden actions and hidden information. Since there is no data on unobservable variables, theoretical contractor-moral moral model is difficult to test directly, but there are some successful indirect tests with field data. The direct test of the theory of moral hazard is feasible in the laboratory setting, using experimental economic tools. In such settings, Hoppe and Schmitz (2018) have corroborated the main insights of moral hazard theory.
Management
Moral hazard issues also occur in working relationships. When a company can not observe all actions taken by its employees, it may be impossible to achieve efficient behavior in the workplace: for example, a worker's effort may be inefficiently low. This is called the principal-agent problem, which is one possible explanation for the unintentional presence of unemployment. Similar problems can also occur at the managerial level because the company owner (shareholder) may not be able to observe the actions of the company manager, opening the door for careless or self-serving decision making.
Moral hazards can occur when upper management is shielded from the consequences of poor decision making. This situation can occur in various situations, such as the following:
- When a manager has a secure position and can not be easily removed.
- When a manager is protected by someone higher in the corporate structure, as in the case of nepotism or pet projects.
- When funding and/or managerial status for the project does not depend on the success of the project.
- When project failure is minimal overall consequence for the company, regardless of the local impact on the managed division.
- When a manager is ready to blame an innocent person.
- When there is no clear way to determine who is responsible for the given project. The software development industry has specifically identified this risky behavior as an anti-management pattern, but it can happen in any field.
- When senior management has its own remuneration as the primary motivation for decision making (achieving short-term quarterly profit goals or creating a high medium-term income, regardless of medium-term effects, or risks for the business so that bonuses can be justified in the current period ). The shield happens because every final blow to the earnings can be explained, and in the worst case, if an executive is laid off, the executive usually keeps a high salary and bonus from previous years.
- When a numbered company is used for a construction project as a subsidiary of a larger company. An example is a numbered company entered to build a condominium in Vancouver, British Columbia. These are built to meet the minimum requirements of building codes, but are not designed for typical Vancouver weather patterns (mild temperatures, plenty of moisture). Several years later, the outer layers of the building were destroyed with mold and rotting. Numbered companies that build it have no assets, so condo owners have to bear the huge cost of rebuilding them. In this scenario, senior officers of the company are numbered, and their shareholders use limited number of limited company protection to take higher risks in design and construction. Unless laws and regulators have several effective ways to hold them accountable, moral hazards will be expected to continue into future development projects. In extreme cases, moral hazards can cause or allow control fraud to occur, where actual illegal activity occurs.
See also
References
External links
- Board, Shaila (February 26, 2012). "Moral Hazard: Ideas Taken from the Tempest". The New York Times .
- Gladwell, Malcolm (August 29, 2005). "Moral Hazard Myth". The New Yorker .
- "What is Moral about Moral Hazard?". Press.illinois.edu
- "Inside the Meltdown", the episode of PBS Frontline uses the idea as a central theme
Source of the article : Wikipedia
0 Comments