Question

2.Discuss how the actions of the US government and the Federal Reserve to stabilize the financial system in 2008 can lead to a possible rise of moral hazard problems on the

financial markets.

Answer 1

Moral hazard problem is one where an entity engaged in risk taking behaviour based on set of expected outcome where another entity bears the cost in case of unfavorable outcomes.

actions of federal reserve in 2008 can trigger a moral hazard problem because many of the industries are involved in high risk taking activities and they started to believe that in case of any mishap there is Federal Reserve who is going to bail out all of them, so they are not keeping a check on their risk taking ability and they are fully exposed to high risk transaction in order to maximize their profit but on the cost of various bailouts expectations from Federal Reserve.

in 2008 federal reserve in order to save the economy from the great recession and stabilize the economy Federal Reserve did a lot of monetary bailout programs as well as mergers and acquisitions in order to save many entities to avoid the financial collapse completely, so entities who are engaged in risk taking products starting to believe that in case of unfavourable outcomes when they would not be able to sustain in the long run, there is Federal Reserve who is not going to let them sink and its going to provide them with required bailout and liquidity.

This mismanagement of risk from various entities can lead to serious trouble on United States economy if there is another financial collapse.