WASHINGTON — Though the Federal Reserve Board's reputation is built on its management of monetary policy, Chairman Ben Bernanke said Wednesday that the role of banking supervision at the central bank needs to be revisited.
"One of the key issues that's going to be debated as we look at the problem of bubbles in the future is what should be the leading approach," he told the Economic Club of New York. "Should it be monetary policy, or should it be supervision and regulatory policy? I do believe the latter does have a significant role to play in constraining excessive leverage, excessive risk taking, and the other elements that lead to bubbles."
The comments were Mr. Bernanke's most expansive discussion of the economy and the banking industry since Congress gave the Treasury Department authority this month to purchase troubled assets and take equity stakes in financial institutions. Though he acknowledged the severity of the industry's troubles, he said the Fed is responding differently than it did when turmoil at banks led to the Great Depression.
"We didn't wait for three-and-a-half years as the financial market collapsed to take action — and strong action — to stabilize the financial system," he said. "The actions taken this week, together with all the efforts that have been ongoing with the provision of liquidity and other things over the past year, are powerful steps to try to stabilize the financial system."
In a reminder of the tough job that still lies ahead for Mr. Bernanke, the Fed released its periodic study of economic conditions Wednesday and found credit conditions remained tight nationwide. As the financial crisis deepens, the Fed said, loan quality continued to decline in several of its districts.
Several bankers told the Fed that customers are "taking steps to ensure that existing deposits are covered by insurance," and that withdrawals increased after reports of bank closings last month.
The Bush administration has been criticized in recent weeks for favoring policies, such as its recapitalization plan, that would provide the most help to the nation's largest banking companies. Over the weekend the Fed approved Wells Fargo & Co.'s deal to acquire Wachovia Corp.
But Mr. Bernanke stressed Wednesday that he did not want a banking system dominated by massive institutions.
"I don't want to see this country go to the point where we have six large banks," he said. "We need to have that diversity. We need to have the information capital, the local knowledge that is incorporated in local lending, local community banking, and diversity of different types of community institutions. That's an important policy consideration in the long run."
Mr. Bernanke reiterated his "very serious" concern that some institutions are viewed as "too big to fail" by the market. "There are too many firms that are in some sense systemically critical."
He also defended the government's decision to let Lehman Brothers file for bankruptcy protection, even though the Fed bailed out American International Group Inc. days later. Unlike Bear Stearns Co., which the Fed rescued in March, Lehman had no acceptable collateral it could provide the central bank, Mr. Bernanke said.
"The Federal Reserve's ability to lend, which was used in the Bear Stearns case, for example, requires that adequate collateral be posted so we are not taking credit risk," he said. "In this case, that was impossible. There simply wasn't enough collateral to support the lending."