For everyone who worries that Washington has been unpredictable in its efforts to fix the financial system, you have a sympathetic ear in the CEO of the Federal Reserve Bank of Philadelphia.
Reform is absolutely necessary, Charles I. Plosser said on Friday at a New York University conference. But it should not be rushed.
“In general, I believe making major policy reforms in the ‘heat of battle’ risks adopting policies that have unintended consequences,” he said in a speech you can read here on the Fed’s Web site.
In the case of Bear Stearns, American International Group and Lehman Bros., the government responded in three very different ways. The lack of consistency has led many to worry over how federal authorities will deal with other wounded goliaths that pose “systemic risks.”
Plosser said uncertainty over possible federal response is itself another source of systemic risk.
One thing the policymakers should not do is to devise a system in an effort to “drive the probability of failure to zero.” Why not? The costs to supervise such a utopia would be huge. The system could “stifle innovation,” Plosser said. And markets would work to evade the regulations anyway.
“Reforms should seek to reduce the cost of failures of systemically important financial firms, which would enable regulators to allow such firms to fail when appropriate,” he said.
In other words, whatever system we come up with, we want to avoid an AIG-like bloodletting where the price tag starts at $40 billion only to run to $160 billion six months later.
To craft a good response, however, federal authorities need to define what “systemic risk” means and determine which financial firms are too big to fail, Plosser said.
That way, if an institution is too big to fail, regulators may choose to shrink it. Or to increase the costs so greatly on such firms that they would choose to limit their systemic risks, he said.
As for who should ride herd on the stability of the entire financial system, Plosser sees a role for the Federal Reserve to play, but he cautions against giving it a mandate that is “too vague or too sweeping.”
He said: “We should not ask the Fed to take on responsibilities that would undercut its ability to achieve its monetary policy objectives.”
On the Spot
The Financial Times’ chief economics commentator, Martin Wolf, will speak to the Global Interdependence Center at the Federal Reserve Bank of Philadelphia, Seventh and Arch Streets today at noon.
He’s the author of Fixing Global Finance, which he wrote more than a year ago - just in time for the globe’s finances to shut down. Wolf will talk about the persistent financial crisis as well as the U.S. government’s efforts to promote recovery. Here's a link to an interview earlier this month between Wolf and YaleGlobal Online.
Today: Hill International;
Tuesday: C&D Technologies, Marlin Business Services;
Thursday: Orthovita, Safeguard Scientifics;
It takes an environment where, kind of, greed is good. And we still have a good time. We still feel good about life. We seem to be transported to Scandinavia. We have to hide our wealth, drive old cars, take care of the poor, and have great health care and flashy money is not a good thing.
- Daniel R. Lee, chairman of Pinnacle Entertainment, on a conference call with analysts Friday, referring to the $2 billion casino his company had planned to build on the Atlantic City Boardwalk and the economic challenges that have put the project on indefinite hold.