Moral hazard in equity contracts
In some instances, the seller of security is driven by incentives to conceal information from the purchaser and may engage in detrimental activities. This constitutes the problem of moral hazard in equity contracts. An example is the problem of Principal-Agent, which concerns the separation of possession and management of firms. The executives in corporations in this case only own a small share of the firm compared to the principals/share-holders. The managers then opt to pursue their interests at the expense of the firm's profitability bringing about a conflict of interest between the shareholders and corporate management (Banerji, and Basu 70). The solution to this problem is through monitoring, though a costly measure, government regulation (to avail more information about managers), financial intermediation and obtaining of debt contracts.
The cause of the Savings and Loan meltdown in the 1980s
This distress in the financial sector inherent in the savings and loans industry was brought about by the heightened inflation and interest rates in the late 1970s and early 1980s (Kronovet 70). This led to the withdrawal of funds by depositors and the loss of value of the long-term fixed-rate mortgages made by the S&Ls.
The government, however, took the measure to allow insolvent firms to continue operating thus causing the worsening of the situation. The insolvent firms engaged in risky project hoping they would pay off given their higher returns but unfortunately their plans did not materialize thus passing the burden to the taxpayers.
The banking industry was however not hit by the turmoil since it had a stronger examination, supervision, and enforcement measures in place compared to the S&Ls' actions.
Issues with financial institutions
Financial institutions face the problem of controlling risk given the lack of information regarding those seeking funds. In adverse selection, sellers possess information that buyers lack, and there is the tendency of those faced by high risks to obtain deals. In the moral hazard, the risk that exists is that of misappropriation of funds by the receiver. The law of unintended consequences application in these two scenarios stems from the fact that in adverse selection, the risky people will be willing to take up deals contrary to the expectations of the financial institutions (Sabrina et al. 370). As for moral hazard, funds given to individuals may end up being misused resulting to defaulting which is against the expectations of the agencies.
The lemons example
The lemons model infers that any given product has a higher value to the potential buyer than the existing owner and it is economically efficient to trade it for a price greater than the seller's value but lower than the customer's value.
For instance, in used cars, the value of the car to the customer is higher than the seller's value. Since the buyer is not aware of the seller's value of the car, the car will be traded to him/her at a price above the car's real value to the seller. On the contrary, this price could also be lower than what the buyer envisaged.
In stocks, buyers and sellers of shares have an asymmetry in information vis-à-vis the value of shares (Herweg, and Müller n.p). This results to the selling of these shares at a price lower than the buyer's value but higher than the seller's value.
Four Common Elements of Financial Crises in the U.S. since 1980
In all the financial crises, lack of stable financial structures has been a standard feature. Financial activities need to be combined to achieve optimum efficient sizes that can cushion against crises. The government intervention measures have continuously led to imbalances thus worsening the situation. Most of these crises have been characterized by the lack of international co-ordination, which undermines how effective international regulations are in solving these crises (Coricelli, Karadimitropoulou, and Leon-Ledesma 485). Conflicts between goals of different regulatory bodies have also been a common feature in the crises. This has undermined the development of universal regulations that can help curtail these crises.
Goals of Central Bank
Some of the significant roles of the central bank include implementation of different monetary policies that manage the economic growth and employment rate of a country. The central bank has the mandate to manage stability of a country's financial system as an effective strategy through which inflation is curbed in any given country (Tamás 37). The central bank through the Fed is mandated with a rationale to manage production and distribution of a country's currency. Finally, the central bank has a goal of ensuring that the public is informed of its economic state through the regular publishing to help different stakeholders to make informed investment decisions.
b. The most important goal
The most important goal is the implementation of the different policies as they are the ones that control the growth and employment rate of any given country. This is achieved through the fiscal and monetary policies as through the above tools; a country can manage its employment rate and the amount of money that is supplied to the economy to manage inflation.
Works Cited
Banerji, Sanjay, and Parantap Basu. "Borrower's moral hazard, risk premium, and welfare: A comparison of universal and stand-alone banking systems." The Journal of Economic Asymmetries 12.1 (2015): 61-72. Web
Coricelli, Fabrizio, Aikaterini Karadimitropoulou, and Miguel Leon-Ledesma. "Reallocation Effects of Recessions And Financial Crises: An Industry-Level Analysis." B.E. Journal of Macroeconomics 16.2 (2016): 485-522. Print
Herweg, Fabian, and Daniel Müller. "Overconfidence in the Markets for Lemons" Scandinavian Journal of Economics 118.2 (2016): 354-371. Print
Kronovet, Alan. "Chapter 2 in the History of Cmbs: Coming To Terms with the New Rules." North Carolina Banking Institute 20 (2016): 67. Web
Sabrina, Volpone et al. "Exploring The Use Of Credit Scores In Selection Processes: Beware Of Adverse Impact." Journal of Business & Psychology 30.2 (2015): 357-372. Print
Tamás, Pesuth. "Redefining the Role of Central Banks" Public Finance Quarterly (0031-496X) 61.1 (2016): 34-48. Web
