The issues of finance and economy are of vital importance for the existence of mankind. The recent events in the sphere of financial markets demonstrate the negative effects of various problems for all spheres of social life. This essay will focus on the four basic terms of finance – financial markets, risks, moral hazard, and adverse selection – in order to see their interrelations and practical occurrences in the recent situation in the New York Financial markets. The essay will examine the essence and the importance of the above-mentioned financial phenomena and see how their interrelation, especially in the negative context, can influence the state of things in society.
To start with, it is necessary to define the terms that are going to be discussed in this essay. First of all, the financial market needs definition because it is the basic tern for the other three. A financial market is a mechanism specially created by people that serves the needs of people to sell or buy various kinds of commodities, securities, and other items at low prices according to the transaction needs and market conditions.
Consequently, the terms “risk”, “moral hazard” and “adverse selection” are the reflection of different processes and phenomena that can occur in the financial markets. Risk is, in general terms, the possibility of getting a return on a transaction that will differ from the expected return level. This return level can be worse or better than expected and mean the negative or positive risk. The concept of moral hazard is closely connected to risk.
Moral hazard is a sub-type of risk because it is used to define the risk that a party to a contract acts in contradiction to it to get more profit than expected from the transaction. Finally, adverse selection is the process when persons or companies use the information that their partners do not have to benefit from the transaction or get insurances for large sums of money because of high possibilities of accident happenings and getting compensations.
The current situation in the New York financial markets and in the economy of the whole world demonstrates the importance of all the above-considered phenomena. Financial markets experience a severe crisis caused by the inability of certain huge banks to cover their liabilities and their subsequent bankruptcy. The index of bonds of basic companies fell over the last few days, and Dow Jones faced 220 points decrease.
This, according to Hulse (2008), was caused by the expectations of negative risks from possible transactions. In other words, entrepreneurs were reluctant to invest money because the return they might get was probably worse than they expected. Moral hazards also played a considerable role in the crisis because companies and individual people had no confidence in each other because of the sudden bankruptcies of banks that were not reported beforehand and were shocking for people who had their accounts in the banks (Jakson, 2008). As a result, according to Uchitelle (2008), the small businesses faced the lack of large-scale and long-term loans because the banks that survived the crisis were afraid of adverse selections made by the applicants and refused to credit them.
Thus, the whole picture of the situation in the New York financial markets is the synthesis of the notions of risk, moral hazard, and adverse selections. These phenomena became interconnected and caused the chain reaction started by the crisis in financial markets, continued by the risks and expected moral hazards, and completed by the desire of companies to be protected from the adverse selections that might be observed in the context of the crisis.
References
Hulse, C. “Pressure Builds on House After Senate Backs Bailout”. New York Times, 2008.
Jakson, T., Kramer, S. “Across America, Speaking out the economy”. New York Times, 2008.
Uchitelle, L. “Small Businesses Feeling the Chill”. New York Times, 2008.