Moral Hazard

Moral hazard happens when an individual or organization has an incentive to take on more risk because they believe that another party will bear the consequences of their risk. For example, if a company expects the government to bail them out when faced with a financial crisis, it might make riskier investments than it would otherwise.

Essentially, one party in a transaction has the opportunity to assume additional risks that could negatively affect the other party. This behavior is driven not by what is ethically right but by what provides the highest benefit. For instance, before the 2008 financial crisis, commercial banks took on more risks and leveraged themselves further, confident that the FDIC would bail them out if necessary.