When economists use the term "moral hazard" they mean the fact that when people buy insurance, they might not be as careful as they were before. For example, if you don't have fire insurance for your house, you will be very careful not to create fire hazards. But once you buy insurance, you might not go to as much effort to make sure everything is safe. But that increases the chance that fires will happen.
Reuter's has an article called Popular mortgage "mods" fuel moral hazard by By Al Yoon and Walden Siew. See if you can spot the moral hazard in the excerpt below.
"NEW YORK (Reuters) - Mortgage companies scrambling to ease the terms on thousands of loans destined for default may be doing more harm than good by rewarding investors and homeowners who took on excessive risk.
Efforts to help Americans pay their mortgages have forced companies such as Countrywide Financial Corp (CFC.N: Quote, Profile, Research), the largest U.S. mortgage lender, to expand their practice of loan modifications, which lower payments for borrowers vulnerable to foreclosure. Countrywide on Tuesday said it would refinance or modify $16 billion of loans.
While such concessions are largely a win-win situation for the parties involved, since homeowners keep their homes and the bank reduces losses, the practice may exacerbate a credit crisis that began in July and is leading to growing cries of foul in the $7.2 trillion mortgage bond market.
To some, the loan adjustments are little more than a bailout of bond buyers who were paid to take greater risks. The practice of lowering interest rates or forgiving a portion of the principal could even encourage more of the bad lending that helped create the U.S. housing bubble and subsequent credit crunch."