Moral hazard and bending the rules

Escrito el 30 Agosto 2007 por Juan Toro en Financial Markets

In the recent stockmarket turmoil and interventions by Central Banks two important information problems were at play. One was the adverse selection issue as many banks tried to outguess the balance sheets of their partners. This halted borrowing among them and the appearance of a risk premium in money markets. The second issue was the moral hazard problem that could rise if Central Banks bailed out some financial institutions by cutting rates, setting the precedent that banking malpractice will always find the safe net of a lenient Central Banks. This second issue has been much disputed and many economists have maintained the blunt positions that


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