Moral Hazard and Principal-Agent Problem

Moral Hazard and Principal-Agent Problem
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Moral hazard and the principal-agent problem are concepts used in microeconomics to examine the link between the agent and the principal. The latter is the party making decisions, while the former is carrying out the decisions. The principal-agent problem emerges when incentives are not aligned between the two parties, which can lead to a conflict of interest (Bihary & Kerényi, 2019). Moral hazard is a related concept that deals with the agent's behavior when the principal does not monitor or hold them accountable. In this situation, the agent might have incentives to act in a way that is not in the principal's best interest. Moral hazards and the principal-agent problem can lead to inefficiencies in the market and other issues such as moral hazards. This discussion evaluates the above ideas as learned in the microeconomics class.
Types of Moral Hazards
As learned in the course, moral hazards can be classified into two main types, including ex-ante and ex-post. The former occurs when a person or institution takes more risks without a contract or agreement. For example, a bank can offer higher-than-normal interest rates to attract more deposits, knowing that depositors will not bear all the losses if the bank fails (Momtaz, 2021). Ex-post moral hazard takes place when an individual or institution takes advantage of an agreement by taking more risks after the agreement has been signed. For example, an insurance company might offer low premiums to attract customers but then raise the premiums after the customers have already signed up.
The U.S. has had multiple examples of moral hazard. One of the most prominent examples is the housing market collapse in 2008. In the years leading up to the collapse, financial institutions and other lenders offered low-interest mortgages to borrowers who could not afford them. They did so knowing that the government would step in to bail them out if borrowers defaulted. This event created an ex-ante moral hazard, as the lenders took on more risk than they would have without the promise of a government bailout. Another example is the bailouts of large banks in the wake of the 2008 crisis. This situation created an ex-post moral hazard because the banks were incentivized to take more risks knowing that the government would rescue them if things went wrong.
Implications of the Principal-Agent Challenge
The principal-agent problem can lead to misaligned incentives and objectives, creating an environment where the agent works to maximize their benefit rather than the principal. The problem can significantly impact markets' functioning in the short and long-term and the effectiveness of government policies (Shrestha et al., 2019). In the UK, the principal-agent problem is evident in the banking and finance sector, where customers hire banks and financial institutions to manage their money and investments. In this situation, the financial institution or bank's interests are only sometimes aligned with those of the c...