–Conditions Will Have To Be Worse During Next Crisis Before Fed Can Act

By Brai Odion-Esene

BOSTON (MNI) – The Federal Reserve will be able to serve as a
lender of last resort in the next financial crisis, but “it will be
worse before they can do it,” former Fed Vice Chairma Donald Kohn warned
Wednesday.

“There is less room to maneuver for the authorities, including
the Fed, until we face a situation” he said during panel discussion at a
Boston Fed economic conference.

Kohn stressed the importance of expanding oversight of the non-bank
financial sector — even of those firms that are not considered
systemically important. “Other segments of the credit markets may tend
to become more systemic as some functions are pushed out of banks by
higher capital requirements and new regulations,” he said.

He argued that “attention only to systemically important
institutions in the non-bank world will not be enough to contain
systemic risk. Regulators should watch carefully for any additional need
to go to Congress for additional legal authorities over more lightly
supervised areas.”

Kohn did say the response to the last crisis — Dodd-Frank, Basel
III and other actions taken by regulators — is making the onset of the
next systemic crisis less likely.

“Banks and other institutions will have more capital, greater
liquidity, better risk management systems than they had in 2007 and
2008,” he said. “Intersections among institutions will be less complex
and risk will be easier to monitor, especially in the derivatives
markets.”

In addition, the private sector market discipline should be aided
by additional transparency and efforts to rollback ‘Too-Big-To Fail’,
Kohn said.

However, Kohn said he retains the premise that assets will still be
mispriced, bad loans will still be made, asset price corrections will
happen suddenly and unexpectedly, the financial system will continue to
be based on large amounts of leverage and maturity mismatching will
build when confidence is high.

“So the financial systems will continue to be subject to shocks,”
he predicted. “Some might originate elsewhere in globally connected
financial product markets, and these shocks will be able threaten the
general drying up of liquidity and have the potential to seriously
disrupt credit flows and economic activity.”

Kohn said another premise he retains is that susceptibility to runs
and panics will continue to persist outside of the banking system and
depository insitutions “with potential systemic implications.”

In addition, “it is highly likely that non-bank institutions and
markets will remain systemically important in the U.S.,” he said.

To prevent the occurence of the aforementioned “situation” that
would require the Fed and other regulators to shore up the banking
system once again, Kohn said it is important to prevent weaknesses from
building up in the financial system.

“We have to stay out of resolution or the threat of resolution,” he
said. Kohn added that regulators should insist on high levels of
loss-absorbing capital and liquidity, especially for systemically
important institutions.

“Intervene early in weaker institutions before they can endanger
the system,” he urged, which would require tough but fair regulatory
oversight.

Resolution plans for the wind down of a failing large institution
should be as consistent as possible with maintaining financial
stability, Kohn continued, counselling that ‘living wills’ be used to
“simplify complex enterprises so systemically important pieces can be
isolated.”

It is also important to have compatible resolution regimes
internationally, he said, and understandings of how they would work in a
crisis.

In addition, private lenders must perceive that their funds will be
at risk in the event an institution fails, that they will not be made
whole by the government, Kohn said.

** Market News International **

[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$]