Calling too-big-to-fail banks "the most critical issue facing our financial system," a top Federal Reserve official on Tuesday urged new laws to address the problem, including ending Fed emergency lending powers.
"During the crisis, and still today, many people view government-provided backstops to large financial firms as a necessity to prevent financial system malfunctions," Richmond Federal Reserve President Jeffrey Lacker said in remarks prepared for delivery to the Stanford Institute for Economic Policy Research.
But so long as those backstops are seen as available, he argued, investors will continue to take risks they would not otherwise take, making the financial system less, not more, stable.
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Although Wall Street reform legislation went some way toward preventing new bailouts, Lacker said, more legislation would be "useful," including revamping the bankruptcy code to limit exemptions and rewriting rules that now prevent money market funds from suspending redemptions under stressed conditions.
"Credible commitment to orderly unassisted resolutions thus may require eliminating the government's ability to provide ad hoc rescues," Lacker argued. "This would mean repealing the Federal Reserve's remaining emergency lending powers."
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The Fed's role as "lender of last resort" should not extend to bailing out insolvent, large institutions whose failure is seen as a threat to broader financial stability, he said. And during the crisis, he argued, the Fed ended up acting as a backstop to private entities that otherwise could not have gotten the financing they wanted.
—By Reuters