It is a basic axiom of neo-liberal thought that the private sector is inherently superior to the public sector. Not only that, it is more moral than the government. However the private sector, specifically the financial sector, has for the last two decades suffered from the problem of moral hazard. For a long time, it has been accepted amongst economists and business people that government regulation is a form of market distortion. Regulations imposed by fiat lead favor some forms of behavior over others. Instead of the government imposing its will, the private sector should be allowed to self-regulate. This will succeed because any business that acts in a fraudulent or self serving manner will be punished by the market. Consumers will flee from such organizations and competitors will take advantage.
This idea presupposes that not only do consumers have complete access to information they need to make an intelligent, informed decision but they also have the capability to analyze and understand this information. Unfortunately, this is not the case. Producers generally have far greater information than consumers. They also have a very strong incentive to hide relevant information. Many of the products that they sell, specially financial products, are highly complicated and opaque. Indeed financial innovation has introduced products which can literally be understood only by mathematicians and physicists. In such circumstances, firms have a very strong incentive to accentuate the positive and downplay the negative. How then are consumers expected to make informed decisions?
This is the basis of moral hazard. When companies are insulated from the risks of their actions, they have a very strong incentive to behave in a riskier fashion. This has certainly been true of the financial sector. New, innovative products were highly opaque and extremely difficult to understand. These also had a very high element of risk. These were sold to parties that were far less sophisticated and in most cases were in a poor position to take on the associated risk. These products also did not stay confined to the financial sector; they spread rapidly into the industrial sector. By the time the whole house of cards collapsed in 2008, many firms which were (and still are) viewed as industrial ones had become in fact financial firms. Household names like GE and GM derived much of their profits from financial products. In addition, most of these firms were so large that their bankruptcy would have serious repercussions in the wider economy. This was the second leg of the moral hazard problem; companies that were simply too big to be allowed to fail.
This means that managers in these organizations have a strong incentive to take on extraordinary, even foolish risks. The probability of these risk exploding in their face was small and by the time the whole structure collapsed, they were likely to have moved on to greener pastures. Their entire remuneration structure encouraged them on to take these risks. The upside was simply too large to ignore while the downside was limited.
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