Microeconomics 6th Edition by Robert Hall, Shirley Kuiper, Marc Lieberman

Exercise 10

During the financial crisis of 2008,market failures occurred other than those discussed in the Using the Theory section. For each of the following,identify the market failure. (If asymmetric information,identify the specific type: moral hazard,principal-agent,or adverse selection.)a. Troubled financial institutions tried to raise cash by quickly selling financial assets (such as bonds backed by mortgages)to other institutions. However,managers at the other institutions assumed the assets being offered were especially risky,and would pay very little for them. As a result,some troubled institutions stopped selling all but their most-risky assets.
b. Managers at financial institutions were given huge bonuses when they took risks that paid off. As a result,they took many risks that even their institutions' owners (stockholders)would not have approved of,knowing that the owners could not monitor their every move. In effect,they treated stockholders as "outsiders" rather than owners.
c. Some managers made risky investments that could cost their firms billions of dollars if the investments turned out badly. They knew,however,that they would not have to cover these losses; the worst that could happen to them was losing their jobs.
d. When making investments,managers at financial institutions often considered the costs and benefits to themselves and their stockholders,but they did not consider how their decisions might contribute to instability for the financial system as a whole.