Better regulation is needed to dissuade financial market players from taking excessive risks after the "too big to fail problem" undermined discipline, a senior Federal Reserve official said on Tuesday.
Philadelphia Federal Reserve Bank President Charles Plosser said there were ways to discipline the market — some within the market itself — to prevent excessive risk taking.
His comments followed statements from Federal Reserve Chairman Ben Bernanke, who said over the weekend that regulators should be significantly tougher on large and complex financial firms.
"The too big to fail problem has essentially removed much of that market discipline," Plosser told an economic conference in Prague.
"We have to have ways of disciplining the actors in the marketplace so that they don't take excessive risks, and in many cases the market can do that and do that quite effectively," he said. "But when we protect creditors, when we protect people from failure, we encourage them to take risks."
Bernanke made clear at the weekend that large financial firms continued to play a crucial role in the global economy. Plosser said different, but not necessarily more, regulations were needed.
"I believe we do need better regulation. It is not obvious to me that we need more regulation, but we need to do it differently," said Plosser, a non-voting member on the Fed's policy setting committee this year.
The comments from both officials follow the unveiling of a regulatory reform proposal by Senate Banking Committee Chairman Christopher Dodd that would put the Fed in charge of overseeing banks and financial firms with assets of more than $50 billion.
The Fed already has authority over big banks but lacks power over non-bank financial firms like insurer AIG, one of the main focal points of the global financial crisis.
Plosser's comments were general, and not specifically directed at Dodd's proposal. He added that that regulators would never be able to be out in front of market innovation.
"Government regulation and government oversight will never replace the marketplace officially ... markets, firms ... when there is regulation they will look for ways around that regulation in order to be successful," he said.
"We will always as regulators be behind that curve. The only way we can be effective in protecting financial stability is to have regulations and rules that complement and encourage more market discipline, not replace it."
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