We have all heard of “moral hazard”. It is something that was said to have kept Treasury Secretary Hank Paulson awake at night when he was agonizing over how to thaw out the frozen inter-bank credit system in mid-late 2008. Moral hazard is defined as the risk that the monetary powers that be take when they create “money” out of thin air for the express purpose of bailing out banks and corporations whose failure would drag the entire economy down with them. In 2008, it loomed large in the US.
The problem is that economic “booms” and “busts” are an inherent part of any economic system where prices and interest rates are NOT set by the markets but by those in power to control them. Those in power love to take credit for the booms but they don’t want to be faced by any busts. Thus, every time that a credit-based economy “falters”, the temptation to spice the punch bowl with another dollop of credit money is irresistible. From there it becomes orthodox “policy”. And from there it becomes “politically impossible” to do otherwise. Mr Paulson couldn’t stand up against that orthodoxy. That is not surprising.
The only US monetary official who has at least partially bowed to markets was Paul Volcker at the end of the 1970s. And he only did it after an ultimatum from the Europeans in late 1979. “Either let US interest rates rise to reflect the risk of holding US Dollars or we’ll dump them wholesale”. He had no choice.
Moral hazard is “risk” that too big to fail financial entities will not be allowed to fail. The only means to put such a failure off is to literally keep pumping money into them. That process guarantees eventual failure. The longer it is put off, the bigger it will be and the more certain it is that the entire economy and financial system will be dragged down in its wake.
Market-set interest rates in the US – especially for US Treasury paper – only lasted from late 1979 until mid 1982. They have not been resorted to since and everything conceivable is being done to prevent them from asserting themselves now. The hazard of a “voluntary” reversion to financial morality is warded off like a dread disease. The “authorities” never tire of painting pictures of Armageddon if they had “done nothing” in 2008. Europe is being vilified for not doing “enough” now. This has led to a situation in which the debt “underpinning” the system is too big to do anything but fail. Hence the sudden realisation that “sovereign debt” is not risk free.