NEW YORK (MNI) – The following is the fifth and final section of
the text of remarks of Simon Potter, executive vice president, New York
Federal Reserve Bank, prepared Monday for the Third Annual Connecticut
Bank and Trust Company Economic Outlook Breakfast:

Conclusions

Looking back over the run-up to the financial crisis and its
initial stages, it is obvious now with the benefit of hindsight that
short-term tactical missteps and long-term strategic miscalculations
were made by both the private and public sectors. Many of the long-term
strategic miscalculations were related to allowing perverse incentives
to build within the financial system and allowing significant gaps in
the regulatory framework to persist. The financial reform proposals
currently being considered by Congress are appropriately trying to
ensure that such perverse incentives are removed from the financial
system and exploring ways to endow regulators with an efficient
resolution mechanism for systemic financial institutions. Some of the
short-term tactical missteps were the failure of banking regulators to
force high quality capital raises early enough in the crisis, and the
failure of the private sector to engage in adequate liquidity
contingency planning and the failure of regulators to recognize the
vulnerability of the system to erosion in liquidity conditions.

As the crisis intensified to unparalleled heights and without an
efficient resolution process in place, the ability of the Federal
Reserve, and then other governmental agencies after the TARP
appropriation, to act with speed and flexibility was vital to
stabilizing the system.

However, hindsight is much less definitive on some of the lessons
about the underlying stability of the financial system. In Alan
Greenspan’s thoughtful review of the crisis he summarized the issue this
way:9

“The aftermath of the Lehman crisis traced out a startlingly larger
negative tail than most anybody had earlier imagined. I assume, with
hope more than knowledge, that this was indeed the extreme of possible
financial crisis that could be experienced in a market economy.”

This motivates a final lesson coming out of this crisis, which is
that policy making, whether it is fiscal, monetary, supervisory or
other, must always strive to be as forward-looking as possible, and to
be robust to the possibility that we will experience situations tomorrow
that are unimaginable today.

_____________________________________________________________________

1 I would like to thank my colleagues Meg McConnell, Jamie
McAndrews and Brian Peters for numerous useful comments and suggestions
on these remarks.

2 The Challenge of Central Banking in a Democratic Societyoffsite

3 Primary dealers are broker-dealers who trade in government
securities directly with the Federal Reserve.

4 In the 1930s, Congress had passed legislation giving the Federal
Reserve additional flexibility in its lender-of-last-resort powers but
these were removed with the passage of the small business investment act
in 1958.

5 Most of this information can be found at the Board of Governors
of the Federal Reserve System’s Credit and Liquidity Programs and the
Balance Sheetoffsite

6 The recent testimony by Thomas Baxter and Sarah Dahlgren provides
a detailed explanation: Joint written testimony of Thomas C. Baxter and
Sarah Dahlgren: The Federal Reserve Bank of New York’s Involvement with
AIG

7 The time-out of an extended bank holiday used by U.S. President
Franklin D. Roosevelt in 1933 was not available.

8 Around $1 trillion was drawn but the total capacity of the
existing and new facilities offered by the Federal Reserve was closer to
$4 trillion.

9 The Crisis, by Alan Greenspan, March 9, 2010 Draft.

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