PHILADELPHIA — A day after Federal Reserve Board Chairman Ben Bernanke defended financial market interventions as necessary to avoid a deeper crisis, another central bank official said the actions had worsened problems posed by large companies.
"Rather than limiting moral hazard and the 'too-big-to-fail' problem, we have made them worse during the crisis," Federal Reserve Bank of Philadelphia President Charles Plosser said Friday. "In trying to stabilize the financial system, we have led creditors of large financial institutions to expect that the government will protect them from losses, which in turn means they need not monitor risk-taking by these firms."
Plosser's comments were made at a policy forum sponsored by the Philadelphia Fed, where other central bank leaders echoed his concern about the lasting impact of their interventions.
"The crisis may have unwittingly set up expectations of future intervention that could be influencing markets today," said James Bullard, the president of the Federal Reserve Bank of St. Louis.
During his confirmation hearing before the Senate Banking Committee on Thursday, Bernanke said, "The Fed does not want to be involved in bailouts" but argued that it had had little choice during the crisis.
"Taken together, the Federal Reserve's actions have contributed substantially to the significant improvement in financial conditions," he said.
Speaking to reporters on Friday, Plosser acknowledged the difficult position the Fed was in.
"We had two very unpalatable choices to make," he said. "We could either let them fail and suffer the consequences for the broader economy, or introduce moral hazard. We chose the moral hazard route, and now we have to live with that."
In the aftermath of the crisis, Plosser said, it is important for Congress to establish a resolution process for mammoth financial companies, a cause for which Bernanke has long lobbied.
But Plosser would not endorse legislation that passed through the House Financial Services Committee on Wednesday; he stressed that whatever lawmakers ultimately enact must impose pain on creditors.
"If Congress merely expands the safety net by enlarging the list of firms that have access to government resources or increases the opportunities for the government to take over firms, we will have failed to solve the problem," he said. "A resolution mechanism is a bankruptcy mechanism. That is, shareholders are wiped out, unsecured creditors face losses, and the firm is either liquidated or sold to other private parties rather than becoming a ward of the state."
Though Bullard has pushed the Fed to buy debt and mortgage-backed securities from the government-sponsored enterprises beyond the March 31 deadline it has established, Plosser said that this would be unnecessary as long as the financial system improves.
"If the economy continues to recover, I wouldn't be enthusiastic about going out and buying more," he said. "I don't think it's necessary at this point."
By the time the program expires, the Fed plans to have purchased $1.25 trillion of mortgage-backed securities and $175 billion of debt from the government-sponsored enterprises.
Plosser echoed other Fed officials who have expressed confidence in the central bank's ability to wind down the liquidity programs that were established to aid the financial industry. The Fed will probably pay banks more interest on the reserves they hold at the central bank, he said, though he did not say how much more.
