Volker Says Obama Plan Will Lead to Moral Hazard

Former Federal Reserve Chairman Paul Volcker voiced his concern while testifying before the House Financial Services Committee yesterday, that the Obama administration’s plan to create a council of regulatory agencies to be headed by the Treasury department was akin to the government sanctioning reckless behavior. According to Volcker, such a move would signal to the industry that the government is prepared to ensure that no major bank will be allowed to fail; this could be interpreted in some circles as a de facto insurance policy and could encourage the type of risky actions that led to the currency crisis in the first place.

Volcker – who now serves as Chairman of the White House Economic Recovery Board – was recruited by Barack Obama to help lead the US out of the current recession. He certainly has the credentials, having been in charge of the Fed from 1979 to 1987, and is universally credited with pulling the US out of a dangerous stagflation crisis which gripped the US economy during the 1970s.

Volcker argued that instead of creating new regulatory agencies under the umbrella of the Treasury Department, the role of the Federal Reserve – an independent Central Bank operating at arm’s length from the government – should be expanded to have more oversight of the entire financial system. This would make it abundantly clear to the institutions and the public alike, that while the government supports greater oversight of the industry, it will not participate directly in the markets.

“It’s a natural function for the Federal Reserve,” Volcker told the Committee. “There’s no doubt when you get into trouble, when anybody in the financial market gets into trouble, they run to the Federal Reserve.”

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