By Steven K. Beckner
WASHINGTON (MNI) – New York Federal Reserve Bank President William
Dudley Friday blamed the United States “unusually anemic recovery” on
the severity of the financial crisis and its aftermath.
Speaking two days after the Fed’s policymaking Federal Open Market
Committee adopted new measures to lower long-term interest rates, Dudley
said the build-up of debt that led to the crisis and the crisis itself
has hindered a normal recovery despite “aggressive” monetary and fiscal
easing.
Although progress has been made in immunizing the financial system
against future crises, reform is “far from complete,” the FOMC Vice
Chairman said in remarks prepared for delivery to the Bretton Woods
Committee.
The meeting was taking place on the anxiety-ridden sidelines of the
annual meetings of the International Monetary Fund and World Bank, as
well as discussions among Group of 20 finance ministers and central
bankers.
Since the FOMC announced plans to buy $400 billion of longer term
Treasury securities and to reinvest in mortgage backed securities in
the face of what it called “significant downside risks,” stock prices
have plunged, although they stabilized a bit Friday.
Dudley, who supported the new stimulus measures, did not elaborate
on the FOMC actions, taken on a contentious 7-3 vote. But he spoke
briefly about the difficult atmosphere for monetary policymaking and
explained why past Fed moves have not been more successful, before
turning to financial regulatory issues.
“It is clear that the build-up of debt during the years prior to
the crisis, as well as the crisis itself, has contributed to an
unusually anemic recovery,” he said. “This has occurred despite the best
efforts of policymakers to stimulate demand through aggressive monetary
and fiscal easing.”
Dudley said the economic hangover from the crisis shows the need
for far-reaching financial reform.
“The extraordinarily poor economic outcomes we see today underscore
the importance of building a financial system that is resilient in its
ability to provide credit to households and business throughout the
business cycle,” he said. “It also underscores the importance of
limiting the types of financial and real imbalances that develop during
times of prosperity.”
“When such balances unwind, they can cause significant damage to
the financial system and the economy,” he added.
Dudley said, “We have made progress in reforming how we oversee and
regulate the financial system,” but “our work toward achieving a more
stable and dynamic system able to deliver its essential services to both
savers and borrowers is far from complete.”
“We must keep pushing this agenda forward and not be deterred by
those that defend the status quo,” he said, adding, “we should not be
dissuaded by those who argue that the costs of reform are too high or
that the job is simply too difficult.”
Dudley said “policymakers and market participants must acknowledge
that the financial system is inherently unstable — that it is prone to
booms and busts, and that these episodes can destabilize the real
economy. As a consequence, at times, we must be willing to intervene to
restrain financial booms in order to temper the busts.”
As examples of what he thinks needs to be done, Dudley said,
“making financial markets and institutions, in their practices and
structure, less prone to amplifying and propagating shocks is a critical
step. This means, in particular, that regulation should be designed to
create incentives that operate over sufficiently long time horizons so
that the entire cycle of boom and bust is included.”
After citing the need for better risk management, more capital,
more transparency and better incentive structures, Dudley said, “we have
made a good start, but there is a long ways to go.”
He said more “cross-border coordination” is needed. Bank capital
has been raised, and regulators are in the process of imposing a capital
surcharge on “systemically important” banks, which he said is justified
because their failure “would generate a very large shock to the rest of
the financial system.” But he said stronger capital alone is
insufficient.
Likewise, he said “U.S. banks have bolstered their liquidity
buffers and the Basel Committee has proposed a liquidity coverage ratio
requirement that effectively would require large, systemically important
banks to hold sufficient liquid assets so that they could reasonably
conduct their operations for 30 days without having to raise any new
funds.”
“However,” he said, “progress on the liquidity front has not
progressed as far as desired.”
Dudley also stressed the importance of making faster progress on
insuring that “financial market utilities,” such as clearance and
settlement systems are “robust.” So far, he said “progress is slow and
uneven.”
“For example, it is unlikely that the G20 countries will meet the
goal to clear all standardized over-the-counter derivative trades
through central clearing counterparties by the end of 2012,” he said.
“Similarly, I have my doubts whether the next set of industry
recommendations to reduce risk in the triparty repo market will be
sufficient to eliminate all the major potential sources of
instability.”
Dudley said he also thinks “the scorecard is mixed with respect to
making financial institutions, in their practices and structure, less
prone to amplifying and propagating shocks.”
And he complained that “information about counterparty exposures is
not broadly available.”
“Similarly, there has been little progress made with respect to
reengineering the financial system so that the transmission mechanisms
act to dampen rather than amplify shocks,” he went on.
In yet another area that is pertinent at a time of anxiety about
the vulnerability of large banks to the Greek debt crisis, Dudley said
“there has been progress” on procedures for “resolving” large
systemically important financial firms that get into trouble. But he
said “a major challenge remains in implementing resolution effectively
on a cross-border basis.”
“The legal rules and regulatory regimes differ across legal
jurisdictions,” he said. “So, when a multinational banking organization
becomes insolvent, each subsidiary and affiliate must be resolved in
multiple bankruptcy proceedings, with the prospect of inconsistent
treatment and larger than necessary losses in aggregate.”
“Although the Financial Stability Board has taken up this issue,
the legal impediments to progress here are significant despite the best
efforts and intentions of regulators,” he continued. “The difficulty in
implementing an efficient cross-border resolution is one of the reasons
why the largest globally active firms are being asked to hold additional
capital.”
** Market News International Washington Bureau: 202-371-2121 **
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