Can Privatization Alleviate the Moral Hazard Problem?
Proponents of privatization generally assume that the moral hazard fostered by deposit insurance can be eliminated through privatization. In fact, the problem of moral hazard is inherent in insurance itself, regardless of management or ownership. The private provision of deposit insurance does not by itself alleviate the moral hazard problem. Although moral hazard was clearly problematic in the savings and loan crisis, subsequent improvements in federal banking regulation and supervision have given the FDIC better tools to control moral hazard. The moral hazard problem created by deposit insurance has been mitigated by capital standards, examinations, safety–and–soundness regulations, enforcement actions, and timely bank closure policies. In particular, Prompt Corrective Action (PCA), introduced under FDICIA, has been effective in preventing banks with low capital levels from taking on excessive risk in an effort to return to profitability while the FDIC bears the risk. A properly cons
