Arnold Kling on the Financial Crisis
In hindsight, within each sector affected by the crisis, we can find moral hazard, cognitive failures, and policy failures. Moral hazard (in insurance company terminology) arises when individuals and firms face incentives to profit from taking risks without having to bear responsibility in the event of losses. Cognitive failures arise when individuals and firms base decisions on faulty assumptions about potential scenarios. Policy failures arise when regulators reinforce rather than counteract the moral hazard and cognitive failures of market participants.
This is a key paragraph, and there are many key paragraphs, in Arnold Kling, “The 2008 Financial Crisis,” the latest entry in David R. Henderson, ed., The Concise Encyclopedia of Economics.
I thank Arnold for being responsive, and quickly, to suggestions by some referees, particularly Jeff Hummel.