Question

What role (if any role) did "moral hazards" play in the financial crisis of the last decade (2007-2008)?

Answer 1

The financial crisis of the last decade (2007 - 2008) was a very apt example of the concept of moral hazard.
To explain it in very simple terms, the 2007-2008 crisis happened because all banks and big financial institutions of the US thought that were "Too Big Too Fail". In this belief they basically designed financial products, rather complex financial products which were so financially engineered that they were out of the reach of understanding of even the experts sometimes. These products were then sold to the general public which more often than not failed to understand what was underlying to these financial products. All this was done with a big belief that the banks and financial institutions were "Too Big Too Fail" and in the event of a financial collapse there would be a central government which would bail them out.

This is what is mean by "Moral Hazard". The primary problem with this was that it sort of serves as an example to other institutions and initiates a chain reaction. Other financial institutions take cue from these major banks and begin to do the same. Any slippage and it leads to a ripple effect as it happened in 2007-2008. A major financial crisis and a one of its kind recession took place shaking up all the global markets and even other economies.

The ability of taking more risk knowing that there is someone who would bear part of the risk is moral hazard. This, while it is fatal as was seen in the case of the financial crisis, should be avoided at all costs because an example of this kind should not lead to future generations to act in a similar way.