During the 2007 Great Recession the US Government bailed out many large financial institutions. Critics of the bailout claimed that the policy creates a moral hazard problem.

(a) Explain how bailouts can create a moral hazard problem.

(b) If banks can take on risky investments where they earn $80 if the project is successful, but lose $100 if unsuccessful, and there is a 50% chance of success, will risk-neutral banks take on the project?

(c) What if the government offers a 30% bailout if the project is unsuccessful (that is, 0.3($100) = $30)