The Moral Hazard of Risktaking

“Moral hazard occurs when one party is involved in risktaking, but knows that, should the decision turn out to be a bad one, someone else will pay the price. When this happens, there is a distortion in the decision-making process. Because the potential gain is high and the cost of potential loss will be borne by others, there is an incentive to take high-risk decisions that would not otherwise be justified. The assumption behind the derivatives involved in subprime mortgages was that they effectively outsourced the risk. Besides which, if anyone considered the risk of massive defaults, they surely believed – rightly as it happens – that the major banks were too big to fail: if governments allowed them to do so, whole nations would suffer. So the bankers did not have skin in the game in the way that their customers did. They were not going to lose, whatever the outcome. While the global economy was on the brink, I did not encounter a single report of a banker expressing remorse, guilt or shame that others were suffering while they walked free and without loss. They seemingly could not understand the moral enormity of the irresponsibility they had perpetrated against trusting customers.”

Morality, Chapter 6, p. 95