Considering the government-sponsored enterprises like Freddie Mac, fannies me, and others, do you see any indication that the managers of these agencies are creating a moral hazard? Explain.

Question

What will be an ideal response?

Answer 1

These agencies can borrow at interest rates less than what private lenders must pay because they are viewed as being "backed" by the U.S. government. Because of the lower rate that they can then offer or the guarantees they can provide on private mortgages, their services are in high demand. If the managers really believe that they will ultimately be backed by the U.S. government in the event of not being able to meet their obligations, they (as well as the stockholders) have a strong incentive to take on a lot more risk than if the implied guarantee from the U.S. government did not exist. Also, due to the sheer volume of business done by these firms they may be in the "too big to fail category" which also compounds the moral hazard issue.