In response to the 2008 ﬁnancial crisis, the government began to bail out banks deemed "too big to fail." Critics of this action argued that this would create the prospect of future bailouts and
Encourage banks to be ﬁscally irresponsible in the future. This illustrates
A) the adverse selection problem.
B) the moral hazard problem.
C) the principal-agent problem.
D) logrolling.

Question

Quizplus · Accepted Answer

The moral hazard problem refers to the tendency of people or businesses to take on more risk when they are insured against that risk. In this case, the government's action of bailing out banks that were considered "too big to fail" created the moral hazard of encouraging banks to take risks in the future because they knew that they could be bailed out again if things went wrong.

In Response to the 2008 ﬁNancial Crisis, the Government Began