nuthing new here but...Banker warns over Fed’s credit moves
ByJames Politi in Washington
Published: June 5 2008 20:28 | Last updated: June 5 2008 20:28
A senior Federal Reserve policymaker on Thursday warned that US central bank moves this year to extend credit to Wall Street investment banks carried a significant danger of “moral hazard” and could encourage risky behaviour in the future.
Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, said in a speech at the European Economics and Financial Centre in London: “The danger is that the effect of recent credit extension on the incentives of financial markets participants might induce greater risk-taking, which in turn could give rise to more frequent crises, in which case it might be difficult to resist further expanding the scope of central bank lending.”
As turmoil in the financial markets deepened in March, the Fed took two crucial steps: it decided to back JP Morgan’s takeover of Bear Stearns with a $29bn loan, and it allowed access to its emergency cash facility, known as the discount window, to investment banks.
Mr Lacker will not be a member of the Federal Open Markets Committee – which sets interest rates and regulates the discount window – until the Richmond Fed rotates into a committee seat next year. Nonetheless, his comments are the strongest acknowledgment yet from within the Fed of the potentially negative consequences of these moves.
Donald Kohn, Fed vice-chairman, on Thursday defended the Fed-backed rescue of Bear Stearns, suggesting that moral hazard concerns were outweighed by the potential for a meltdown of the entire financial system.
“Our judgment was that had Bear Stearns been allowed to walk into bankruptcy court, that would have disrupted the financial system and had very serious effects on the economy,” he told the Senate banking committee, adding: “If something like this were coming again, I would have to make the same kinds of judgments.”
Mr Kohn also warned legislators that banks would continue to suffer due to the housing crisis. “The housing market bottom isn’t here yet,” he said. “Prices are continuing to fall in many localities.
“As long as the housing market is on a downward path, there is a risk that the losses could continue to mount on a variety of loans.”
In the wake of the Bear Stearns rescue, pressure has been building in Congress for tighter regulation to be imposed on investment banks, since they are benefiting from access to the Fed discount window, which until recently was only available to commercial banks that hold consumer deposits.
While it is unlikely that any new legislation will advance this year, senior lawmakers responsible for economic policy are laying the groundwork for possible changes to financial regulation next year. The Treasury Department itself issued a blueprint for regulatory change in late March.
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