Moral hazard in the financial system “looms larger than ever before,” even after the Dodd-Frank law gave U.S. federal agencies tools to regulate institutions that may be deemed too big to fail, said billionaire investor George Soros.

“The evidence is overwhelming that the first priority of the authorities is to prevent a market collapse, and everything else has to take second place,” Soros, chairman of Soros Fund Management LLC, said yesterday at a conference in Bretton Woods, New Hampshire.

Paul Volcker, former Federal Reserve Chairman, challenged the notion that large financial institutions wouldn’t be allowed to collapse, and asked Soros whether the extra yield on Goldman Sachs Group Inc. bonds relative to Treasurys would widen if the firm gave up its bank license.

“Probably currently it wouldn’t go up very much, but it would go up,” Soros said.

The Fed allowed investment banks Goldman Sachs and Morgan Stanley to convert to bank holding companies in September 2008. Dodd-Frank, the financial-regulation law enacted in July, gave the Federal Deposit Insurance Corp. authority to wind down complex firms after the bankruptcy of Lehman Brothers Holdings Inc. exacerbated the credit crisis and forced the U.S. to bail out companies including American International Group Inc.

“So you’re not 100 percent sure,” Volker replied. “You want a tough administrator, you get Sheila Bair up here and she’ll tell you what will happen if you fail on her watch.”

Federal Deposit Insurance Corporation Chairman Bair told bankers last month that while the Dodd-Frank law is not “perfect,” it will strengthen the sector by giving the agency tools to regulate “too-big-to-fail” institutions.

Goldman Sachs Notes

Goldman Sachs’ $1.5 billion of 5.15 percent notes due January 2014 traded at 107.21 cents on the dollar to yield 111.6 basis points more than similar-maturity Treasurys as of April 8, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

“It’s clear they’re clinging to this banking license they got during the crisis because they think the market would permit them to fail if they weren’t a bank,” Volker said. “Otherwise, why would they be holding onto the banking license with all the additional regulation?”

Volcker, 83, is known for taming inflation in the 1980s as Fed chairman and he provided advice on economic issues as well as the rewriting of regulations for financial institutions. The law enacting those regulations included the so-called Volcker rule, which banned proprietary trading at banks and restricted their investments in private-equity and hedge funds.

He was President Barack Obama’s head of Obama’s Economic Recovery Advisory Board and was replaced by General Electric Co. Chief Executive Officer Jeffrey Immelt.

Moral Hazard

Europe’s refusal to allow members of the monetary union to restructure their debt has added to moral hazard in the financial system, Soros said. Portugal will start negotiations with the European Union and the International Monetary Fund this week on a rescue package estimated at 80 billion euros ($116 billion). The country was forced to seek aid, following Greece and Ireland, after its budget gap helped drive up borrowing costs.

“Look at the situation in Europe, for instance, where authorities are insisting on no renegotiation or restructuring on outstanding debt because that could possibly provide a financial banking crisis,” Soros said. “At the present we bail out, but in the future we will bail in. It has absolutely no credibility.”

Soros Bets

Soros, 80, reportedly made $1 billion in a successful bet in 1992 that Britain would fail to keep its currency in a European exchange-rate system that pre-dated the euro. Other successful trades included a bet that the deutsche mark would rise after the collapse of the Berlin wall and a wager that Japanese stocks would start to tumble in 1989.

He and Volker spoke at a conference sponsored by the Institute for New Economic Thinking, which Soros helped found and supports.

U.S. and European officials met in Bretton Woods in 1944 to draw up rules that governed much of the world economy for almost three decades. Nations agreed to fix exchange rates, establish the International Monetary Fund and start the process of rebuilding Europe’s economy in the aftermath of World War II.

The Bretton Woods era ended in 1971, when inflation forced the U.S. to abandon the dollar’s peg to gold, an anchor of the system, heralding the era of floating exchange rates.