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Bernanke's Inflation Concerns Intensify
New York Fed President Timothy Geithner says the nation's financial regulation system needs to be consolidated.
(By Daniel Acker -- Bloomberg News)
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"Inducing institutions to hold stronger cushions of capital and liquidity in periods of calm may be the best way to reduce the amplitude of financial shocks on the way up," Geithner said, "and to contain the damage on the way down."
He said that big financial firms need to push harder to bring order to the Wild West-style markets for derivatives, sophisticated financial investments for which products trade irregularly, often privately, and with few guarantees that the other party can fulfill their financial obligations under a trade.
One of the major reasons the Fed leaders backed the emergency acquisition of Bear Stearns was that they feared that if it been allowed to dissolve overnight, it would have created chaos in derivative markets.
Geithner, echoing an elaborate proposal by Treasury Secretary Henry M. Paulson Jr., said the nation's fragmented system for regulating banks and other financial institutions needs to be consolidated -- and in Geithner's vision, the Fed would take on new power. Currently the Fed can order commercial banks to adjust their exposures to a given type of asset or to improve their systems for measuring risk -- but has no such formal power for investment banks and a range of other financial institutions.
"At present the Federal Reserve has broad responsibility for financial stability not matched by direct authority," Geithner said, "and the consequences of the actions we have taken in this crisis make it more important that we close that gap."
He stopped short of proposing new regulation of hedge funds or private-equity firms.
Geithner said that fundamentally too much regulation of big financial firms is oriented toward making sure they can remain solvent -- not on making sure the financial system as a whole keeps functioning.
"Risk management and oversight now focuses too much on the idiosyncratic risk that affects an individual firm and too little on the systematic issues that could affect market liquidity as a whole," Geithner said.
