Despite blistering criticism of the Federal Reserve Board's interventions in financial markets, Chairman Ben Bernanke said Friday that central banks should be prepared to take similar actions if another serious crisis erupts.
Bernanke noted that regulators are working with banks to better manage liquidity risk in the hopes of avoiding the kind of runs that contributed to the Lehman Brothers collapse. But he said those measures alone are not sufficient during severe turmoil.
"Liquidity risk management at the level of the firm, no matter how carefully done, can never fully protect against systemic events," he said in a speech at the Federal Reserve Bank of Kansas City's annual economic symposium. "In a sufficiently severe panic, funding problems will almost certainly arise and are likely to spread in unexpected ways. Only central banks are well positioned to offset the ensuing sharp decline in liquidity and credit provision by the private sector."
The Fed has done that over the past two years by lending to individual institutions against safe collateral, creating a host of liquidity programs and liberalizing access to the discount window.
Bernanke took the opportunity to reflect on the central bank's response to the financial crisis over the past year. He said that while markets were clearly in a recession, the problem was really more akin to a "classic panic" where an institution's funding quickly evaporates.
"The role played by panic helps to explain the remarkably sharp and sudden intensification of the financial crisis last fall, its rapid global spread, and the fact that the abrupt deterioration in financial conditions was largely unforecasted by standard market indicators," he said.
