Nobody seems to have pickup up on this story - worth reading
Lacker Says Fed Lending to Investment Banks Risks More Crises
By Craig Torres
June 5 (Bloomberg) -- Richmond Federal Reserve Bank President Jeffrey Lacker said the lending to securities firms that the central bank introduced in March may lay the seeds of further financial crises.
``The danger is that the effect of the recent credit extension on the incentives of financial-market participants might induce greater risk taking,'' Lacker said in a speech to the European Economics and Financial Centre in London. That ``in turn could give rise to more frequent crises,'' he said.
Lacker urged that the central bank now ``clearly'' set boundaries for its help to financial markets. In an interview yesterday on the themes of his speech, Lacker said even those new boundaries may not be believed by investors unless a financial firm fails ``in a costly way.''
The remarks are the strongest warning by an official about the consequences of the Fed's aid to securities dealers, the first lending to nonbanks since the Great Depression. While other regulators have focused on tightening investment-bank oversight in exchange for the lending, Lacker said there's a case for ``scaling back'' the new programs.
Lacker, 52, heads a district that is home to two of the four biggest U.S. banks. A former head of research at the Richmond Fed, he alone dissented in interest-rate votes at the Fed in late 2006, wanting to continue raising them to stem inflation.
Let `Fail'
``Establishing a new set of boundaries for central-bank lending is a high priority,'' Lacker said in the interview. ``You would expect that'' the limits ``aren't going to be credible unless we let somebody fail in a costly way that is beyond that scope,'' he said.
Fed Vice Chairman Donald Kohn said today that banks will probably report ``weak earnings'' and ``may likely face the need to further bolster loan-loss reserves,'' in testimony to a hearing at Congress. In a speech last week, he raised the possibility of giving securities dealers permanent access to the Fed, as long as regulators toughen their supervision.
Chairman Ben S. Bernanke and New York Fed President Timothy Geithner defended the central bank's rescue of Bear Stearns in a congressional hearing in April. They stressed that the firm's failure would have cascaded through the financial system because of its connections with other firms through trading positions.
Hard to `Resist'
Lacker said the challenge now is it ``might be difficult to resist further expanding the scope of central bank lending.''
He didn't mention any specific firms. Lehman Brothers Holdings Inc., whose stock has dropped 26 percent in the past month on concern about its vulnerability to further losses.
If investors anticipate an official intervention to limit losses in ``situations of financial stress,'' firms will be less likely to take ``costly'' measures to protect themselves, Lacker said.
The central bank's loans, including $30 billion of financing to secure the takeover of Bear Stearns Cos., were ``appalling,'' former St. Louis Fed President William Poole said after he retired in March. Gary Stern of Minneapolis and Tom Hoenig of Kansas City have lamented the expansion of the Fed's lender-of-last-resort role, though they supported the actions.
The March actions were the ``worst policy decision in a generation,'' Vincent Reinhart, former head of the Fed's monetary affairs division and now a scholar at the American Enterprise Institute in Washington said in an April 18 speech.
Types of Runs
Lacker in his remarks distinguished between ``fundamental'' runs on financial institutions where creditors have good economic reasons to question their investments, and ``non- fundamental'' runs typified by panics.
He said a case can be made for intervention to stem disorderly non-fundamental runs. He doesn't see a case for action when a crisis is unavoidable based on a deteriorating credit or business plan. ``Instances of run-like behavior since last summer appear to be attributable to real fundamental causes,'' Lacker said in his speech.
In the case of Bear Stearns, Lacker said in the interview that it's hard to tell whether the New York-based firm's crisis was due to fundamental reasons or a creditor panic.
Lacker, who will vote on the rate-setting Federal Open Market Committee next year, said rising public expectations for the rate of inflation have ``gotten'' his ``attention.'' If there is a risk of inflation expectations rising ``significantly, we need to shade policy higher than we otherwise would,'' he said.
Traders anticipate the Fed will keep its benchmark interest rate at 2 percent this month, ending seven rate reductions since September.
New Programs
The central bank has introduced three programs since December to help counter the credit crisis. Along with the Primary Dealer Credit Facility, the Fed lends Treasuries to dealers in exchange for mortgage and asset-backed debt through the Term Securities Lending Facility. The Term Auction Facility offers cash loans to banks.
Lacker indicated skepticism about the value of the programs.
``It isn't clear what kind of market failure is being addressed'' with the TAF, he said. Central bankers should be wary ``that they can substitute their own judgment about the fundamental value of financial instruments,'' he said.
A lack of legal structure to facilitate the liquidation of a troubled investment bank is ``the nub of the problem'' he said. Setting that up ``ought to be a high priority,'' Lacker said. |
