Scarcity, Risk And Debt...or the more new normal the better! 

No systemic risk to see here...move along.

In effect, The Fed's ZIRP (Zero Interest Rate Policy) and easy credit have leveraged up systemic risk and moral hazard. Moral hazard describes the difference between those who risk losing money in a speculation and those with no risk of loss. Those with very limited risk--for example, Too Big to Fail (TBTF) banks backstopped by the Fed or FHA home buyers putting down 3% cash on a home--will act quite differently from those who risk losing their all their capital if the bet goes bad.

Put another way: if all your losses at the casino are covered by the Fed, while any winnings are yours to keep, you will gamble big and gamble often. After all, why not? The losses are shifted to someone else while you get to keep any gains.

Abundant, easy credit incentivizes systemic speculation, leverage and risk. If you're issuing mortgages guaranteed by the U.S. government, there is no need to be too risk-averse: originate a mortgage for anyone with a pulse and skim the fat origination fee. If the borrower defaults, who cares? You skimmed your fee, and all losses are shifted to the taxpayers.

When skimming and speculation are more profitable than actually increasing the production of goods and services, the discipline and incentives of a market economy are distorted to the point of no return. That is the U.S. economy in a nutshell.

The only way to restore natural market discipline is to let the cost of credit rise to a market-discovered price, force all speculators to absorb the losses resulting from their bad bets, and let the risk of losses discipline lenders to adjust loan portfolios and interest rates to reflect the risks of rising rates and defaults.

Scarcity of credit is the source of sound risk assessment and the discipline of aligning interest rates to risk and inflation. Manipulating rates to near-zero and opening the credit floodgates has incentivized everything sound economic policy avoids: moral hazard, speculation, leverage and reliance on marginal credit expansion for profits and "growth."

"Growth" that depends on manipulated interest rates and easy credit is a sand castle awaiting the rising tide; its destruction is assured.

by Charles Hugh-Smith of OfTwoMinds blog