Subprime and Moral Hazard

If you haven't already,you're likely to hear the term "moral hazard" more and more often. As the subprime debacle evolves, banks and regulators are faced with a dilemma. Should they bail out those in financial trouble?

Critics say that any bailout creates a moral hazard. Moral hazard comes from the insurance industry, where people might gain financially by acting immorally. Regarding the mortgage mess, moral hazard might result from risk-takers realizing that they can take unlimited risk - and depend on the regulators or their lender to bail them out.

We've seen a few lenders shut their doors or lay off employees. These events undoubtedly create strain and hardship for anybody involved. Likewise, borrowers lose their home when they default on a mortgage. The regulators have to walk a fine line - do they allow the suffering to continue or do they perform a rescue and risk moral hazard?

Further reading:

• WSJ on Moral Hazard and the Fed