Federal Reserve Chairman Ben Bernanke. (AP)
(CNSNews.com) – Federal Reserve Chairman Ben Bernanke said that large financial institutions that were too big to fail and needed government bailouts were bad for the market because the presumption of a government bailout meant that “the market is not allowed to work.”
Bernanke, speaking to a conference of financial and economics school teachers, said that too-big-to-fail banks were one example of the combination of government and market failures that can hurt the economy.
“Finally, I’d mention the too-big-to-fail problem, which is sort of a combination of government and market failure,” Bernanke said on Tuesday at the event in Washington, D.C. “Institutions which are so big and complex and interconnected that their failure would possibly bring down the financial system -- there is a strong presumption in the markets that the government will protect those institutions and that means that [the] market is not allowed to work, in a sense.”
Bernanke said the presumption of a government bailout of such large companies stopped the market from functioning efficiently by allowing investors to make risky deals with these large banks, or not care about what the banks do, because the investors think the government will just bail them out.
“[P]eople who lend money to those institutions say, ‘Well, I don’t have to worry about whether they’re making good investments or taking too much risk because I believe that if they get into trouble the government will protect them,” he said.
Bernanke explained that because investors could count on government, they were more likely to engage in the type of risky behavior that could lead to another financial crisis.
“That obviously leads to very bad allocations [of capital], it leads to increased risk in the system,” he said.
Bernanke also praised the free-market concept of the invisible hand moving through the economy, saying that teaching it to students was one of his favorite things as an educator. He said that markets were responsible for the massive wealth creation seen around the globe over the past century.
“One of the most exciting moments in teaching economics is when kids understand the invisible hand idea, the idea that markets can achieve such complex economic outcomes without any kind of central planning,” he said.
“It’s pretty clear to everybody that, looking around the world, markets have played a tremendous role in creating the wealth that we see in rich countries and in emerging markets that are becoming rich,” he said. “So markets are an amazing thing and getting students to appreciate what markets can do is a very important part of teaching economics.”
Bernanke also warned that markets did not operate perfectly, pointing out that things such as natural disasters or human failings could cause markets to fail.
“Markets also have problems, and there are also market failures,” he said. “There’s monopoly, there’s externalities [wars, natural disasters, etc.], there’s many other things that can go wrong in markets.”