The woes of U.S. banks could mount as the economy slows down and with greater access to their confidential information, the Federal Reserve can make sound decisions, Boston Fed President Eric Rosengren said on Friday.
"I would say that while to date the problem banks have been quite low, there clearly has been some deterioration since the beginning of this year, and should the economy continue to slow down, as many expect, it is likely that we will continue to see some growth in the problem institutions," he told a seminar at the Bank of Korea.
Rosengren is regarded as one of the most dovish members of the Fed, but is not a voting member of the central bank's Federal Open Market Committee this year.
The Fed last week slashed benchmark lending rates by a hefty three-quarters of a percentage point to a three-year low of 2.25 percent, in addition to the other measures it has introduced to keep money flowing in markets.
Investors think it will cut rates again at its next scheduled policy meeting, on April 29-30.
"It is too soon to call whether or not we are in a recession. But regardless of what you call it, it is a period of very slow growth," he told reporters at the seminar.
"Slow growth does have the implication that you would expect a gradual increase in the unemployment rate," he said.
On the troubles caused by the subprime loan crisis, he said: "We need to see some stabilisation in the housing market before I would be confident that the financial turmoil is over."
Rosengren said public earnings statements often do not offer enough of a basis for prudent policy.
"While U.S. banks report detailed information on their balance sheets and their income statements, these reports do not provide sufficient information to allow central banks to really discern how banks are responding to problems," he said in a prepared text.
Troubles that began with rising mortgage defaults has since infected the broader financial system, igniting the worst credit crisis in decades.
Rosengren said the turbulence was difficult to foresee because bank models focused solely on their exposure to riskier assets like subprime mortgages, ignoring the possible knock-on effects on other sectors.
"What these stress tests crucially failed to capture was the effect of house price declines on the large holdings of highly rated securities that global banks held -- the products of mortgage securitization activities, with their payment streams ultimately tied to the performance of subprime loans," he said.
The belief that housing prices would never fall on a national basis, which permeated even the Fed itself, was partly to blame for this underestimation of risk, Rosengren said.
Fed's Plosser on Price Stability
The best way for central banks to foster sustainable economic growth and prevent instability is to keep inflation under control, Philadelphia Federal Reserve President Charles Plosser said on Friday.
A broader role for monetary policy is risky, he added, because failure to deliver results could lead to a crisis of confidence in central banking.
"Price stability is not only a worthwhile objective in its own right. It is also the most effective way monetary policy can contribute to economic conditions that foster the Federal Reserve's other two objectives: maximum employment and moderate long-term interest rates," Plosser said in prepared remarks at South Africa's Global Interdependence Center.
His comments come even as the Fed widens the scope of its mandate in an effort to stem a nine-month credit crisis that began in the housing market and has since spread throughout the global financial system.
In its push to revive ailing credit markets, the Fed has already pumped hundreds of billions in liquidity and slashed interest rates by 3 full percentage points since September.
Plosser dissented on the Fed's last policy vote earlier in March, voicing his worry that yet another 0.75 percentage point rate cut was perhaps excessive.
The Fed has also fully embraced the lender of last resort role, expanding the range of collateral it accepts on loans and broadened access to emergency funds at the discount window to a wider array of financial institutions.
Some analysts fear this could eventually boost inflation, especially if the value of securities held by the Fed plummets, thereby forcing the central bank to print money to bolster its own balance sheet.
Plosser seemed to share these concerns to some extent.
"There seems to be a view that monetary policy is the solution to most, if not all, economic ills," he argued.
"Not only is this not true, it is a dangerous misconception and runs the risk of setting up expectations that monetary policy can achieve objectives it cannot attain."
Plosser joined the Fed in 2006 as a known inflation hawk, and has since lived up to that role, providing a cautionary tone in a Fed that is otherwise fully focused on grappling with the short-term effects of the credit crisis.
In his speech, Plosser emphasized the role of transparent communications and independence from the federal government as cornerstones of sound monetary policy.