Fed's Lacker says letting banks fail will restore market discipline

Jeffrey Lacker, president of the Federal Reserve Bank of Richmond.
Justin Solomon | CNBC

Policymakers must ensure that financial industry creditors do not expect government bailouts and must be willing to let firms fail in order to restore market discipline, a top Federal Reserve official said on Tuesday.

The remarks by Jeffrey Lacker, president of the Richmond Federal Reserve Bank, repeated much of what he has previously said about what regulators need to do to make the financial system safer. Lacker, a voting member this year on the Fed's policy-setting committee, did not discuss monetary policy.

The long-term solution to ending too-big-to-fail banks is restoring market discipline "so that financial firms and their creditors have an incentive to avoid fragile funding arrangements," Lacker said in remarks prepared for delivery at the Louisiana State University Graduate School of Banking.

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His remarks come amid heightened concern among Fed officials about financial stability as the U.S. central bank prepares to raise interest rates. But Lacker says less regulation, not more, is needed to make the system safer.

Lacker took aim at what he said are two culprits: the Fed's emergency lending powers and Title II of the 2010 Dodd-Frank Wall Street Reform Act.

Lacker repeated his call to repeal the Fed's emergency lending authority, which he and other critics—including Republican and Democratic lawmakers—believe favors large Wall Street institutions. Lacker also continued his assault on Dodd-Frank's Title II, also known as the Orderly Liquidation Authority.

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Lacker believes that because Dodd-Frank allows the Federal Insurance Deposit Corp. to tap a U.S. Treasury credit line during the liquidation of a bank, the provision serves as a government bailout.

Under Title II, the FDIC would have access to a line of credit from the U.S. Treasury to keep certain bank activities afloat until they can be sold off or wound down. The industry would repay any taxpayer dollars spent in the process

"Rather than ending 'too big to fail,"' the OLA replicates the dynamic that created it," Lacker said.