Moral Hazard
Moral hazard is hidden action after a contract is signed: insurance, a guarantee, or a backstop changes the agent’s incentives and often raises the risk the principal wanted to cover.
Definition
After risk is transferred, the insured party may take more risk or less care because they no longer bear the tail. Deposit insurance, TBTF, and ‘Fed put’ narratives are moral-hazard objects. It is distinct from adverse selection (hidden type before the contract).
Why it matters
Every bailout and every guarantee writes a future incentive. If you price the option and ignore the behavior it induces, you underprice the next crisis.
Case
Wholesale-funded banks that assume a discount-window backstop run thinner liquidity. 2008 and 2023 both showed the put was real — and that it trained the next book.
How to read it
Ask who is protected, who still has skin, and whether the action is observable. Unobservable risk-taking plus a public put is the textbook setup.
Key papers
Landmark references with real publisher or arXiv links — not token-overlap noise.
- Moral Hazard and ObservabilityHolmström · 1979 · Bell Journal of EconomicsPrincipal–agent moral hazard.