When distrust builds among banks and insurers, entrepreneurs face the biggest risk, writes Rebecca Harding, managing director of Delta Economics

Spare a thought for the poor economist as talk of recession grows louder. Suddenly, the public is taking notice and the need to step out of ivory towers and into the real world is paramount. While City economists devised concepts such as credit default swaps, it has been left to the rest of us to explain what they mean and why it matters to Joe Entrepreneur.

The concept of "moral hazard" keeps rearing its head. This isn't what happens when you attend too many office Christmas parties, but is a term that has been around in the insurance industry to explain what happens when somebody is exposed to a risk that has not been made fully clear.

In other words, one organisation, such as Lehman Brothers, starts to sell insurance policies. It asks another firm to pay a regular premium or to take out a bond against the risk that it may default on possible payouts.
But Lehman does not tell the other organisation just how likely it is that it will default and goes on selling credit default swaps as investments, sometimes without bonds. If Lehman then goes bust, the chances are that it will not have the money to pay out to investors and, worse still, cannot fully assess the extent of its liabilities.

Proper pricing is not possible and everyone incurs costs because contracts have not been fulfilled. This leads to uncertainty as a result of the failure to let information flow. This matters to Joe Entrepreneur because if one bank withholds information then it is likely that others will, too. If trust breaks down between banks, then they won't lend to each other. And if that happens then the supply of credit to small firms and households is locked.

The looming recession is part of the moral hazard product. Economists hijacked the term, but should we get the blame for its consequences?