Does collateral fuel moral hazard in banking?

This paper presents two models in which the fluctuating value of loan collateral (real estate) generates the problem of moral hazard between a bank and a deposit insurance agent. The bank finances risky projects against collateral and relies on the rising collateral value. If the collateral value later appreciates, the bank enjoys handsome profits: otherwise, the bank fails, The findings are rather consistent with the characteristics of the topical subprime mortgage crisis. (C) 2008 Elsevier B.V. All rights reserved.