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The Honolulu Advertiser
Posted on: Thursday, August 21, 2008

Fed chief's hands-off policy on bad loans didn't last long

By Sue Kirchhoff
USA Today

Hawaii news photo - The Honolulu Advertiser

Federal Reserve Chairman Ben Bernanke's handling of the credit, financial and housing crises will likely spur debate at a high-profile conference on financial stability beginning today in Jackson Hole, Wyo.

ASSOCIATED PRESS FILE PHOTO | July 2008

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WASHINGTON — What a difference a year can make.

In August 2007, as financial markets began to crumble under the weight of bad mortgage loans, Chairman Ben Bernanke told the Federal Reserve's annual gathering at Jackson Hole, Wyo., that it wasn't the central bank's responsibility — "nor would it be appropriate" — to protect lenders and investors from poor decisions.

Bernanke may amend those remarks tomorrow morning when he addresses the same annual conference on the subject of financial stability.

Since Bernanke's 2007 address, the Fed has negotiated the last-minute sale of investment bank Bear Stearns to JPMorgan Chase, including a $30 billion loan. It has created special lending programs, providing hundreds of billions of dollars to reeling lenders and investment banks, and offered to act as a lending backstop to troubled mortgage giants Fannie Mae and Freddie Mac.

The unprecedented actions have redefined the Fed's relationship with financial markets, but they haven't quelled the market turmoil. They have, however, raised broad concerns about adequacy of financial regulation and the efficacy of Fed actions.

"We are providing (banks) lots of cash to carry them through while they have these bad loans on their books, but yet they are not required to change their business models," says Peter Morici, a business professor at the University of Maryland.

Morici says the bankers gathered in Jackson Hole for what he calls an "elegant picnic" should be taking a tougher line on regulation.

Some say events forced Bernanke to change his thinking.

"It was difficult to judge initially just how problematic things would become," says Kim Rupert, managing director at Action Economics. "Nobody dreamed back a year ago Bear Stearns would have fallen and Fannie and Freddie would be under threat right now."

Rupert says the heightened involvement by the Fed has raised some new issues. The market, she says, "is a little bit concerned now that maybe the Fed is going to overstay its welcome, and almost become Japan-like in not allowing the natural course of some of these problems to take effect. The natural course is for more banks to fail."

Even Bernanke has acknowledged the Fed actions, while necessary, could erode market discipline by insulating some institutions and investors from reckless decisions.

Fittingly, the theme of this year's Jackson Hole conference, sponsored by the Kansas City (Mo.) Fed, is "Maintaining Stability in a Changing Financial System." The three-day meeting, which begins today, includes sessions examining the role of central banks in financial crises, the link between asset prices and credit conditions and implications of recent developments for regulation and oversight.

The conference is particularly topical given growing momentum for a broad overhaul of the complex federal regulatory framework. Treasury Secretary Henry Paulson earlier this year laid out a plan that would make the Fed a sort of super-regulator for ensuring market stability.

In Congress, House Financial Services Committee Chairman Barney Frank, D-Mass., has kicked off hearings on a possible regulatory overhaul.

Some economists warn that sweeping changes in the midst of the worst financial meltdown since the Great Depression carry their own set of risks.

"History suggests that tackling an ambitious agenda for reform in the midst of a financial crisis is an invitation to bad regulation," Robert Hahn and Peter Passell wrote in a paper for the Milken Institute.