Question

Banks in the 1980’s purchased “Junk” bonds and banks in the early 2000’s purchased “sub-prime” securities because Select one: A. bankers did not understand the risks of these instruments. B. bankers were less concerned about the risks because they purchased the assets with depositors’ money. C. they were required to purchase these assets by the government. D. depositors instructed the banks to purchase these assets.

Answer 1

Banks in the 1980’s purchased “Junk” bonds and banks in the early 2000’s purchased “sub-prime” securities because “bankers were less concerned about the risks because they purchased the assets with depositors’ money”

This is called moral hazard. The situation arises when the business takes excessive risk because it is not bearing the cost of the risk. Here the banks were using depositors money to fund risky investments and they were considering themselves “too big to fail” organizations.