Bailouts of loss-making financial institutions pose incentive problems and moral hazards.

Question

Quizplus · Accepted Answer

When financial institutions know that they will be bailed out in case of losses, they are incentivized to take on excessive risk and engage in risky behavior. This creates a moral hazard, as they are not fully accountable for the consequences of their actions. The expectation of a bailout also creates a situation where institutions may prioritize short term gains over long-term stability, as they know they will not be fully responsible for any losses.

Bailouts of Loss-Making Financial Institutions Pose Incentive Problems and Moral