Ron Paul exposed the hidden causes of moral hazard in his opening statement at the House Financial Services Committee’s hearing on “Monetary Policy and the State of the Economy”.
Location: House Financial Services Committee
Event: Hearing on Monetary Policy and the State of the Economy
Ron Paul: Chairman Bernanke, I’m interested in the suggestion that Mr. Volker has made recently about curtailing some of the investment banking risk they are taking. But in many ways I think he brings up a very important subject and touches on it but it’s much bigger than what he has addressed.
Back when we repealed Glass-Steagall, I voted against this even though as a free market person I endorse the concept. The banks ought to be allowed to do commercial and investment banking. The real culprit, of course, is the insurance, the guarantee behind this and the system of money that we have.
In a free market of course the insurance would not be guaranteed by the taxpayers or by the Federal Reserve creating more money. The FDIC is an encouragement of moral hazard as well. I think the Congress contributes to this by pushing loans on individuals who do not qualify and I think the Congress has some responsibility there too.
I also believe there has been a moral hazard caused by the tradition of a line of credit to Fannie Mae and Freddie Mac. This expectation of artificially low interest rates helped form the housing bubble.
Also, the concept still persists even though it’s been talked about is “too big to fail”. It exists and no one’s going to walk away. There’s always this guarantee that the government will be there along with the Federal Reserve and the Treasury and the taxpayer to bail out anybody that looks like it’s going to shake it up. It doesn’t matter that the bad debt and the burden is dumped on the American taxpayer and on the value of the dollar. But it’s still there, “too big to fail” creates a tremendous moral hazard.
But of course, the real moral hazard over the many decades has been the deception put into the market by the Federal Reserve creating artificially low interest rates pretending that there has been savings, pretending that there’s actually capital out there. This is what causes the financial bubbles, this is the moral hazard because people believe something that’s not true. And it leads to the problems we have today because it’s unsustainable, it works for a while but eventually we have to pay the price. The moral hazard catches up with us and then we see the disintegration of the system that we have artificially created.
We’re in a situation coming up soon even though we didn’t already in a financial crisis. We’re going to see this get much worse and we’re going to have to address the subject of the monetary system and whether we want to have a system that doesn’t guarantee that we will always bail out all the banks and dump these bad debts on the people and that it is filled with moral hazard. The whole system is.
So when that time comes, I hope we come to our senses and decide that the free market actually works pretty well. It gets rid of these problems much sooner and much smoother than it is when it becomes politicized and some friends get bailed out and others get punished. And it’s an endless battle so hopefully we’ll see the light and do a better job in the future.