The United States must tackle systemically important financial firms deemed too big to fail through tighter oversight and higher capital buffers, according to remarks by a top Federal Reserve official obtained by Reuters on Tuesday.
Minneapolis Federal Reserve Bank President Gary Stern said in testimony prepared for delivery to the Senate Banking Committee on Wednesday that the United States must ramp up supervision to spot problems early.
Maintaining the status quo with regard to TBTF (too big to fail) could well impose large costs on the U.S. economy. We cannot afford such costs, Stern said in his remarks.
The United States is stress-testing its top 19 banks to ensure they are strongly capitalized if the economy suffers a worse than expected downturn. The results are due to be released on Thursday.
The country is suffering its most severe recession in a generation after a financial crisis blamed on reckless bets on the U.S. housing market.
These also forced the government to rescue investment bank Bear Stearns and insurance giant American International Group last year.
Stern said it was crucial to curb potential spillovers that bring authorities to the rescue when a financial firm does get into trouble. He suggested reducing the losses that failing firms can inflict on their counterparties as one way forward.
He also recommended making banks raise capital levels during economic downturns, and said policy-makers should review tools that create capital when firms need it most.
However, Stern did not support the argument that solving too big too fail meant making financial firms smaller.
I think efforts to break up the firms would result in a focus on a very small number of institutions, thereby leaving many systemically important firms as is.
Moreover, I am skeptical, for the reasons noted above, that policymakers will effectively prevent the newly constituted (smaller) firms from taking on risks that can bring down others, he said.
(Reporting by Alister Bull, editing )