Moral Hazard & WaMu

Moral hazard has gotten a lot of attention throughout the financial crisis, and rightfully so.  There was lots of it going on, and not only at the top.  Investopedia defines moral hazard as "the risk that a party to a transaction has not entered into the contract in good faith."  For a better definition with examples, though, check out Wikipedia.  It does a pretty good job, at the moment.

Marketplace had a piece this week centering around the moral hazard that was going on at Washington Mutual (WaMu).  Marketplace didn't label it as such, but the behavior they report that WaMu's employees were engaging in was definitely moral hazard.  Bank employees were encouraged to give loans to risky borrowers.  None (or very little) of the risk of these mortgages was being borne by WaMu or its employees.  They made the loan and then quickly sold it, so the risk that they created by making the contract was no longer theirs but the new investor's.

WaMu employees were also given bonuses when they overcharged home buyers.  So WaMu was cheating both the home buyer and the mortgage investor, while profiting from the loan origination fee.  WaMu likely wasn't the only bank doing this...

Listen to or read Did WaMu's Fraud Lower Rest of Market? (April 13, 2010).