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Friday, March 29, 2024

Big Bank Moral Hazard: A Look at Paul Volcker’s Fed and June 30, 1982

Courtesy of Pam Martens.

Paul Volcker (right) Hobnobbing at a Group of 30 Event

Paul Volcker (right) Hobnobbing at a Group of 30 Event

By any measure, the taxpayer bailouts and Federal Reserve loans of more than $13 trillion infused into the banking system during and after the 2008 financial collapse eclipse any other period in U.S. history. A growing body of research now suggests that these bailouts have set us up for ever greater episodes of moral hazard.

Kartik B. Athreya, writing for the Richmond Fed, has described moral hazard this way:

“As for implicit guarantees as a source of systemic risk, the idea is this: Any belief among financial market participants especially creditors, that they will be made whole by the public in the event of the failure of the assets they finance (i.e., that they will be ‘bailed out’) will lead them, all else equal, to (i) take greater risks, even if that means becoming ever more opaque or interconnected, and (ii) grow too large.”

Frequently cited as prior misguided adventures into moral hazard by the U.S. government is the bailout of Continental Illinois National Bank in 1984 and the Federal Reserve’s intervention in the Long-Term Capital Management crisis in 1998, where high-risk gambles in derivatives by an obscenely leveraged hedge fund blew up.

There is another stunning example of moral hazard that is rarely discussed today; perhaps because it occurred on the watch of former Fed Chairman Paul Volcker who was intimately involved in fashioning financial reform after the 2008 crisis.

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