Government bailouts should be limited and a clear policy set forth defining who would have access to the government's financial safety net.
That's what former Federal Reserve chairman Paul A. Volcker told a meeting of the International Institute of Finance in Beijing recently, as reported in The Wall Street Journal.
Volcker is also chairman of President Obama's Economic Recovery Advisory Board, so his remarks on the economy may also reflect administration thinking on the subject, and may also be a forecast of reforms to come.
"One unfortunate consequence of the massive public assistance provided both banks and nonbanks in dealing with the present crisis is that moral hazard may, I am afraid, become more deeply embedded."
Moral hazard is defined as an absence of incentive to protect against risk if you are insured against risk.
Volcker, in his speech, cited as a conflict of interest among those institutions which "engaged in substantial risk-prone proprietary trading and speculative activities."
As for hedge funds and private equity funds, that's a different matter, according to Volcker.
"I do not believe they need to be so closely supervised and regulated as depository institutions," he said.
Financial institutions beyond the government "safety net" should not count on government protection, said Volcker. But they may be subject to government oversight.
In an effort to prevent another disastrous financial crisis, the Obama administration wants to empower the Federal Reserve as a "systemic risk regulator" with the right to seize large financial firms tottering near failure.
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