Moral hazard, liability, opportunities, interest, foreign policy, economic, SSPE securitization-special purpose entity, economic factors, financial crisis, Marie Laure Djelic, Joel Bothello, capitalism
The moral hazard problem inherent to the financial safety net provided by the government protection of depositors has been identified as one of the causes of the 2008 financial crisis. Banks endangered financial stability by promoting lending to risky actors and proposed speculative interest rates, which did not completely show the risk associated with their activity, which, in turn, caused them to finance higher-risk projects. Before the crisis, large banks expected that global regulatory bodies would not allow them to go bankrupt, as it would largely destabilize the economy; they were deemed "too big to fail". Therefore, financial stakeholders and managers were under the assumption that they would not have to bear the full cost of the risky behaviors they were taking at the time.
[...] It is appropriately addressed as a pervasive phenomenon rather than as an anomaly that can only be attributed to specific individual or organizational failures. Therefore, it cannot be solved simply by punishing actors breaking the regulations or by improving the quality of governance mechanisms; rather it involves a more fundamental questioning of some of the deep assumptions upholding contemporary capitalism. [...]
[...] Second, managers enjoy limited liability in the sense that they do not bear the full costs associated with unfavorable performance. In an environment of limited liability, the largest risk for managers is that they will be fired, which, arguably far outweighed by the potential gains of risky bets. For instance in, What Happened to Goldman Sachs: An Insider's Story of Organizational Drift and its Unintended Consequences, Steven Mandis examines the consequences of Goldman Sachs' 1999 I.P.O. on the bank's culture and business mix. [...]
[...] In 2008, another source of moral hazard came from the securitization technique, which emboldened banks to take more risks and adopt a short term vision. Indeed, banks4 historically granted mortgages with the intent of holding them until maturity, and if a mortgage holder defaulted, then the bank would risk running a loss. Therefore, the bank granted loans only to actors who could reimburse the principal and the interests. In the article In the shadow of Basel: How competitive politics bred the crisis, Matthias Thiemann explains that securitization encouraged banks to grant loans to risky agents. [...]
[...] Paradoxically, as Matthias Thiemann explains, the implementation of the Basel Accords weakened the capacities states to regulate globalizing financial markets as core capital requirements accelerated the development of securitization6. Evolution of the concept of limited liability In a second part, the authors describe the evolution of the concept of limited liability7. Under limited liability, in a situation of insolvency, shareholders cannot be made personally liable for any of the debts of the company beyond the amount of money they have already paid, or agreed to pay, for their shares. [...]
[...] In the 18th century, in the finance industry, moral hazard was a risk related to the infusion of liquidity during a crisis. The global financial deregulation of the 1980s and the succession of "innovative" financial instruments increased the risk of moral hazard. In States and the Reemergence of Global Finance: From Bretton Woods to the 1990s, Eric Helleiner enumerates four elements behind industrial states support for ending the Bretton Woods order. First, he highlights the political2 difficulties related with maintaining the existing system and the important role of the process of "competitive deregulation" in finance. [...]
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