Over the past several years, the federal government has rescued a few financially distressed banks and other large private companies, and the key reasons for these actions is to stabilize financial markets and to prevent additional business failures that may arise from the original problem. However, critics of these interventions argue that these actions generate a moral hazard problem. Why?
A. Government oversight of rescued firms is typically based on limited information, so the outcome is economically inefficient.
B. Rescued firms will have a difficult time buying insurance in private markets, so the government will also have to insure the firm against losses from fire, theft, etc.
C. Managers have more information about the financial strength of their firm than government officials, so the rescue attempts may be unnecessary.
D. Managers may be more likely to invest in risky projects if they believe the government will save the firm in case of failure.
Answer:D
Over the past several years, the federal government has rescued a few financially distressed banks and other large private companies, and the key reasons for these actions is to stabilize financial markets and to prevent additional business failures that may arise from the original problem. However, critics of these interventions argue that these actions generate a moral hazard problem. Why?
A. Government oversight of rescued firms is typically based on limited information, so the outcome is economically inefficient. B. Rescued firms will have a difficult time buying insurance in private markets, so the government will also have to insure the firm against losses from fire, theft, etc. C. Managers have more information about the financial strength of their firm than government officials, so the rescue attempts may be unnecessary. D. Managers may be more likely to invest in risky projects if they believe the government will save the firm in case of failure.