Question

What events or conditions could make each of these Lincoln investments risky: hotel rooms costing $500,000 to build, raw land, and shopping malls?  Moral hazard is the principle that if people know they will be “bailed out” of a problem they created, then they have no motivation to avoid the problem.  How is FDIC an example of encouraging moral hazard in banking?

Answer 1

In the event of economic recession, huge investments such as building expensive hotel rooms, shopping malls could be risky as the revenue from the hotels or shopping malls may not be at expected levels. In times of recession, investment in raw land can be risky as the land value may not appreciate as expected.

Moral hazard arises when an insured party, due to the existence of insurance, has little or no incentive to take precautionary measures to avoid losses. Moral hazard problems have long plagued the FDIC. The existence of deposit insurance guarantees encourages commercial bank managers to be risk takers because losses are only partially borne by the banks' stockholders. The major portion of bank losses are borne by the FDIC, thereby shifting risk to the FDIC .