Federal Reserve Bank of Richmond President Jeffrey Lacker said bankruptcy without government support is "the first and most preferable option" in the event of a failure by a big financial institution.
The stability of the financial system would be better ensured should investors expect an orderly wind-down of failing firms rather than government receivership and a taxpayer bailout, Lacker said today in remarks prepared for a speech at a Fed conference in Washington.
"The incentives of market participants will be much better aligned with our public policy goal of a financial system that effectively allocates capital and risks," he said. "Large financial firms will prefer to be less leveraged and less reliant on short-term funding. Institutions and markets would, accordingly, be more resilient in response to financial stress."
U.S. lawmakers and supervisors, including Fed officials, have overhauled financial regulation to minimize the odds that taxpayers will be called upon to rescue a financial institution deemed too big to fail.
Lacker has called for lenders to hold more capital if they own a brokerage, and has repeatedly said this year that the best way to overcome the too-big-to-fail challenge is by drawing up detailed plans for the wind-down of failing institutions.
The conference, sponsored by the Fed Board and the Richmond reserve bank, addresses how to create orderly strategies and planning for shutting down large financial firms on the brink of failure.