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Alternate plans and moral hazard.
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Bailout 10: Moral Hazard
The term “bailout” has become a familiar part of the global financial lexicon over the past decade. One of the most widely debated and controversial aspects of bailout is the concept of moral hazard. The idea is that by bailing out failing companies or industries, governments create a situation where those entities are incentivized to take on excessive risk because they know they will be rescued if they fail.
The most recent high-profile example of this phenomenon is the US government’s response to the financial crisis of 2008. The Troubled Asset Relief Program (TARP) was a $700 billion bailout package aimed at stabilizing the financial system by providing capital to struggling banks and other financial institutions. Critics argued that by bailing out these “too big to fail” institutions, the government was effectively rewarding reckless and irresponsible behavior.
In the years that followed, the debate surrounding moral hazard intensified. Proponents of the bailout argued that it was necessary to prevent a complete collapse of the financial system, which would have had catastrophic consequences for the economy as a whole. They also contended that the actions of a few bad actors should not be allowed to bring down the entire system.
Opponents, on the other hand, maintained that the bailout created a dangerous precedent. By bailing out failing companies, the government was essentially signaling to other businesses that they could take on excessive risk without fear of consequences. This, they argued, would only serve to encourage further risk-taking and lead to a future financial crisis.
The debate over moral hazard is not limited to the financial sector. Bailouts have been implemented in various industries, including automotive, energy, and insurance. In each case, the issue of moral hazard has been at the forefront of the discussion.
To address the problem of moral hazard, many economists and policymakers have advocated for the implementation of stricter regulations and oversight. By holding companies accountable for their actions and ensuring that they bear the full cost of their risky behavior, it is believed that moral hazard can be mitigated.
Another proposed solution is for governments to take an equity stake in bailed-out companies, thereby sharing in the risks and rewards of their operations. This approach aims to align the interests of the government with those of the companies it is bailing out, thereby reducing the likelihood of moral hazard.
Ultimately, the question of moral hazard is a complex and contentious issue. While bailouts may be necessary to prevent a systemic collapse or economic catastrophe, they also have the potential to incentivize reckless behavior and undermine the principles of free-market capitalism. Striking the right balance between preventing moral hazard and safeguarding the broader economy is a challenge that policymakers will continue to grapple with in the years to come.
lmaoooo, and here we go again
“You’re making these bubbles more likely to happen in the future.” Its mid 2022 and he could not have been more right.
I have wathed the entire bailout series, it's great! Sal teaches by story telling, which makes it 1) more fun to learn the stuff, 2) more realistic, and 3) it gives some degree of intuition
Whenever we talk about MONEY, GREED appears.
If the government can bail out the institutions, they can bail out the little guy when he screws up. It shows there's one set of rules for the fat cats, and another for everyone else.
Smelly asset
Artificial demand would only leave the crisis for the time to come. The crisis would still be there, because the artificial demand create market price will eventually fade out and by this time more derivatives and investments, of the kind of CDOs, would be there. Hence the crisis would be amplified.
the title of this video is like the title of a video game
"Look at these idiots. They took all this risk and the government bailed them out." lol
effing bankers! lol
Moral Hazard Quantified- Very COOL
"Government support for troubled financial institutions leads to a sizeable wealth transfer from taxpayers to these firms."
http://econ.worldbank.org/WBSITE/EXTERNAL/EXTDEC/EXTRESEARCH/EXTPROGRAMS/EXTKNOWLEDGEOFCHANGE/0,,contentMDK:23327155~pagePK:64168182~piPK:64168060~theSitePK:491543,00.html
Excerpts:
Our objective was to quantify moral hazard arising from government bailouts of global financial institutions. It is widely assumed that government bailouts of financial institutions create moral hazard in financial markets. While this is intuitive, there has been little empirical research on the link between bank bailouts and moral hazard in credit markets. The purpose of our research is to establish empirically this direct link between bailouts and moral hazard. We seek to demonstrate empirically whether investors in global financial institutions have an expectation of receiving government support, and, if so, to provide a measure of that expectation.
Government support for troubled financial institutions leads to a sizeable wealth transfer from taxpayers to these firms. Government interference leads to cheap credit and excessive risk taking for these firms and, ultimately, future costs for taxpayers. If these effects are not taken into account, bailouts can mistakenly appear as surprising successes. By quantifying the hard-to-observe effects of bailouts, our research provides tangible empirical evidence that is missing in current policy debates and public discourse.
This expectation of public support constitutes a subsidy to large financial institutions, lowering their funding costs. As illustrated in the chart below, we find that the implicit subsidy given to large banks provided an annual funding cost advantage of approximately 16 basis points before the financial crisis (from 1990-2007), increasing to 88 basis points during the crisis (2008-2010), peaking at more than 100 basis points in 2008. The total value of the subsidy amounted to about $4 billion per year before the crisis, increasing to $60 billion during the crisis, topping $84 billion in 2008.
Well, yes, but the mum and dad savers who put their money in bank were the inadvertent lenders; meaning the big banks and other actors in the finance industry (ie, real estate) gambled with someone else's money
this is the last and most logical extension of supply side economics.
Stagflation was the end result of public works/ stimulation of demand.
Of the two, stagflation is the lesser. In my opinion.
Mr. Khan, if you can make a video on Eurozone debt crisis or at least Greek debt crisis, it will be great. Thanks
@mintoo2cool The FDIC takes care of people the bank's account holders, up to $250,000 per account.
has anyone shown this to obama? i'm not sure he's aware of what's going on…
@khanacademy bottom line is interest[usury] is the root cause of this problem which is rightly ban in all the major religion and very specifically in islam.i think the system is evil from its core.may god bless you
you say let the back go belly up and let the government lend to the producers of goods and services money directly. but what about the people who have money with the banks. they should not get punished right? the share holders. yeah punish them. lenders to the bank yea. punish them. but what about the people who have money with the bank? i think thats one side of the moral hazard you did not discuss. i liked the way you explained the facts … your opinions … well i dont agree completely …
I still think raising the mortgage interest tax credit would have been a better way to artificially prop up the housing market for long enough to allow the banks to unwind their exposure without artificially depressing prices by rapidly de-leveraging the banks and grossly exacerbating the real underlying problem.
Yes that would work as well. The idea is to create or nurture a sound banking system untainted by toxic assets. I think Sal mentioned that possibily as well in his videos.
"hire the bankers whose institutions were NOT compromised by Toxic assets" why not just put the equity the government wants to create directly in those institutions?
MBS issued by SPV's I get this. The SPV collects the payments and pays these out as dividends to the Securities holder.
Who holds the mortages. Are there say 1000 separate mortages locked away in a vault somewhere? Are the riskier tranches based directly on the risker subset of mortages in a larger pool?
Same way a private bank does. In fact, a smart politician would hire the bankers whose institutions were NOT compromised by Toxic assets. The idea is that the goverment provide the cash to an found a new entity whose banking business is based on traditional banking standards. How it is used or misused will depend on us. We must be always be vigilant as the founding fathers warned. Actually I like what, Nicolas Taleb Nassim suggests. Create a two tier system, Banking and Risk taking entities.
But how does the government run a bank? Wouldn't it most likely be used for political purposes?
Your point is brilliant!. The government creates an economic rescue fund dedicated solely for the lending of capital to the "real" world businesses. The let the cards fall where they may. Why is this NOT being looked at!
Thank you Sir. Great video
Sal, you are doing a great job…figure out a way to increase your exposure! they have these guitar wannabee's with 6 million hits and you are actually presenting video with substance….this country has a severe disconnect between education/awareness and real-world preparation.
-So Say We All
AFAIK, if a company goes bankrupt, preferred share holders get dibs first, when it comes to paying out the money to share holders (so, still *after* the debt holders get their money). Also, they often get a higher divident pay out or somesuch.
CDO's are companies in name only (at least the mortgage backed ones).
Let them go backrupt. Period.
The losers are the shareholders and we move on.
You did a very nice job of explaining the effects of the bailout. I'll add a couple. One, let's look at the providers of the capital: the taxpayers. A bailout forces the taxpayers to transfer their wealth to the presumptive risk takers. Two, I can't believe all the gov't people are idiots because your points are well known by all economists, including Bernanke. So, one is left to think this is a knowing attempt to take over (socialize) an economic sector. It's not just misguided.
IMO the last point made about lending to main street makes the most sense, however decideing who on mainstreet needs the money the most would be a extremely time consuming at best. In a fast falling economy the government has chosen the quickest (maybe not the best) route. They could be very desperate because they see a collapse somewhere we dont.
By Main Street people mean the real economy. However, a fair question is…Do we have a real economy in the United States of America?
Thank you for explaining this to us Sal, it's very helpful. You should be the next economic adviser 🙂
wrong, the government is bailing out the banks and not main street because bailing out the banks is cheeper for the government then bailing out main street. Furthermore, letting the banks fail would cause a total collapse of the hedge fund industry.
In other words, the Paulsen plan is to SOCIALIZE RISK while PRIVITIZING GAIN.
Think about that. You and I get to cover the potential losses, so that people that are making the bad investment still get the reward.
I was being sarcastic with the first two sentences
These government banks we be sold down the line when the economy picks up, and the government will make some profit for the taxpayers. This newly privatized bank will have a pristine balance sheet since they did not take huge risks when loaning out. Foreigners will be happy to give loans to these banks.
No, No, No, that won't work. How would lending directly to the farmer, factory builder etc pay back the foriegn creditors? I think this is the real sinister plan. Good luck getting a loan in future. Good luck even going into foreclosure in future. I bet there will be a law passed very soon to prevent those upside down walking away from their mortgage. How will this be done? We'll the IRS arm of the FED will simply tack your mortgage onto your income taxes.
Direct loans will essentially turn the feds into a bank, at least until these banks come back in 5 or so years. The government can earn interest revenue and then can pass some tax cuts. This takes away all of the relevant moral hazard. This still keeps the economy running, supporting our mom and pop farmers, while rightfully penalizing Wall Street for taking huge risks. I don't see significant inflation coming out of this.
Brilliant.I've learned so much. Thankyou. Best video's on youtube regarding this topic. Keep up the gr8 work.
I agree with you. I don't think direct loans would be a good idea either. I just think that it would have just as good chance of working and at least it wouldn't be as "morally hazardous". Frankly, I don't think we can legislative ourselves out of this.
Savers are not effected if the banks go under. Their deposits are insured (and I think it is good that they are). Also, I am talking generally about commercial and *investment* banks (like Goldman and Morgan Stanley which, until recently, were not commercial banks and therefore did not take traditional deposits).
Excellent. Thank you.
I don't buy, that $5T in assets is worthless. The folks paying the CASH flow to support them might be, but part of cowboy capitalism is to wait until they suffocate.
Instead of buying the paper, the govt should be buying the property.
NO equity is worth ZERO.
Aside the wall street bad decision makers, what is forgotten is that America's 401K's, which are held by 70% of America ARE not separable.
There is no moral hazard, if reregulation surfaces that defines and curtails, risk taking to professionals.
These undertakings where the govt lends to private industry should not come without strings.
Your argument would be true for most mortgage back securities. Remember, CDO are MBS's sliced up so many of these CDOs may be the riskier tranches (or buckets) that get wiped out only if you have a 10% loss on the underlying assets (or collateral)
Man these are freaking great!!!!!
next video please?? and these CDO's that you speak of… what happens if it is worth 0$, and those people that needs to pay mortgage and these companies go bankrupt?? who collects the monthly payment and what happens to those who cannot afford them?
Especially given the fact that there is only a limited timeframe for this to happen before the real economy starts to get hurt
Very well explained and informational. I want you to congratulate on your series. But I have to disagree with you in one point. How do you want to lend money directly to the whole real economy. Banks are not just holding mortgages or corporate loans but also credit card loans,student loans and I don´t know how many other type of loans etc. The administration necessary to provide 700 bill. to the real economy without banks monitoring etc. is huge.