Reforming the financial system in the wake of the current crisis, including picking out what still works and what needs to be replaced, should take on a larger role for policymakers St. Louis Federal Reserve Bank President James Bullard said Friday. Speaking before the 119th annual Arkansas Bankers Association convention, Bullard said the problem is that large institutions are not too-big-to-fail, but rather are simply too-big-to-fail quickly.
The resolution system for smaller banks should be adopted for larger institutions, Bullard suggested.
Specifically, Bullard noted that the monitoring practices and rating system in place for the smaller banks appear to be working well.
Deposit insurance and prudential regulation have proven to be successful in avoiding small bank panics, he said in prepared remarks. Supervision allows the regulator to anticipate potential bank failures and prepare accordingly.
In addition, smaller banks are can close without harming others in the industry, in part due to the fact that a closure of a smaller banks does not have the same ripple effects of a larger financial institution and there is a clear resolution regime in place through the Federal Deposit Insurance Corporation's formation of a bridge bank.
The system is not designed to keep banks in business at all costs, or to tell owners how to run their businesses, but rather to turn potentially disorderly failures into orderly failures, Bullard explained.
His remarks echoed the opinion of FDIC Chairman Sheila Bair, who earlier in the week suggested that financial firms should be limited in size, effectively preventing the too big to fail problem. Bair called on the Obama administration to abandon its too big to fail policy, instead creating a federal authority that could unwind the remaining systemically important firms.
What's needed is a new way to unwind these big institutions, Bair said in remarks before the Economic Club of New York. We need an effective resolution mechanism, not a get-out-of-jail free card. Taxpayers should not be called on to foot the bill to support non-viable institutions because there is no orderly process for resolving them.
As FDIC Chair, Bair is acquainted with the existing procedure for systemically important commercial banks that near bankruptcy. When a large commercial bank is in trouble, the FDIC steps in to operate a bridge bank, limiting financial disruptions.
Several top policymakers, including Fed Bank members like Philadelphia Fed President Charles Plosser, have called for a similar procedure for systemically important financial institutions.
We need a new resolution regime for large financial institutions, Bair said. Creating such a resolution authority would be very bold, but needed.
Plosser, Bair, and now Bullard have called for a resolution mechanism for financial firms that explicitly addresses the tradeoff between reducing financial disruptions and minimizing the costs to taxpayers. Who should be in charge of the federal authority remains unanswered.
In his remarks Friday, Bullard noted that the effective resolution for small banks is lacking for lager non-bank financial firms.
These firms are often thought to be too big to fail, but Bullard said that they are only too big to fail quickly. He appeared to support the resolution mechanism supported by Plosser and Bair, where failure is allowed without causing significant market disruption.
Bullard stressed that a good resolution regime for these firms must be credible, so that all market participants understand what will happen in the event of failure.
In terms of the Fed's role in the post-financial crisis regulatory structure, Bullard supported the Fed's expanded role in the regulation of firms that have access to the discount window. The Fed President also noted the link between the Fed's ability to keep its finger on the pulse of the financial system and its tie to effective monetary policy.
In short, the St. Louis Fed President said that the Fed has been the nation's de facto systemic risk regulator.
However, his views are at odds with others in the Fed, including Plosser. There has been talk of appointing the Federal Reserve to run a bridge institution to oversee the organized failure of a systemic institution.
In a speech in late March, Plosser expressed his opposition to this role for the Fed, warning that it would threaten the U.S. central bank's independence.
Doing so may result in serious conflicts of interest between monetary policy and the resolution of a single institution and thereby threaten the Fed's independence, he said.
Fed Chairman Ben Bernanke has also urged that the system allow an orderly failure of an institution, similar to those allowed for FDIC insured banks.
An important element of addressing the too-big-to-fail problem is the development of an improved resolution regime in the United States that permits the orderly resolution of a systemically important nonbank financial firm, Bernanke noted in a March 20th speech. Improved resolution procedures for these firms would help reduce the too-big-to-fail problem by giving the government the option of safely winding down a systemically important firm rather than keeping it operating.
He has said that the Fed will likely be involved in the regulatory structure.
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