Tags: Kohn | Wessel | Fed | bank

Fed's Image Is Polished at GWU — Part II

By    |   Thursday, 19 Dec 2013 08:23 AM

Former Federal Reserve Vice Chairman Donald Kohn, who served for more than 40 years in the Federal Reserve System and is now with The Brookings Institutions, sat down with the Wall Street Journal's David Wessel, author of In Fed We Trust: Ben Bernanke's War on the Great Panic of 2009, to talk about what he had learned during his career. Wessel himself will soon be joining Brookings.

In response to Wessel's introductory question, Kohn recalled that he had studied economics because he understood that it is a field that can affect public policy, and he joined the Federal Reserve Bank of Kansas City and then took the opportunity to move to the Board of Governors in Washington for the same reason. He added that public policy can make people better off, if it is done right.

Wessel suggested that the Fed was "returning to its roots" by tackling the panic of 2008 after "screwing up" policy in the 1930s, when it failed to stem the Depression, and in the 1970s, when it failed to control inflation.

Kohn remarked that Fed Chairman Ben Bernanke had studied the Depression and found that the FDR administration was willing to experiment and to do "whatever it takes" to contain the recession.

Wessel quipped that commentators have credited the Fed with "preventing two-thirds of a depression."

In a departure from the administration's narrative, Wessel ventured that the 2008 episode "did not arrive from Mars," and he referred to charges that the Fed had failed to take needed supervisory action for 10 years.

Kohn attributed the 2008 episode of the ongoing financial crisis to a number of factors that contributed to a "zeitgeist" since the late 1990s that financial innovation should be given wide latitude, and he acknowledged that the Fed bears some responsibility, then asserted that, "No one foresaw the kind of collapse that was coming." (I have come to suspect that the only people who didn't see what was already happening were ensconced at the banking agencies.)

Importantly, Kohn also pointed to increased leverage, a lot of which he said was outside the banking system. (This could be arguable, because banking organizations had expanded into a wide variety of nonbank activities conducted through holding companies that are supposed to be supervised by the Fed.)

Kohn pointed to a mismatch between overnight funding and long-term assets, many of which were illiquid securities that counterparties did not want to lend on, and when highly rated mortgage-backed securities declined in value, the banks did not have an adequate capital cushion to absorb losses. Kohn said the Fed saw its role as "reassuring markets that the banks could take losses but still be viable." (I would call this a restatement of the mischievous policy of "too big to fail.")

Kohn expressed his reservations that use of section 13(3) authority to assist troubled institutions, a provision that had been dormant since the Depression, would entail moral hazard, and he doubted that it would be used, but he defined the problem as rebuilding the balance sheets of the troubled banks.

Pressed by Wessel as to when the Fed should taper asset purchases, he whispered, not yet.

(Archived video can be found here.)

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Robert-Feinberg
Former Federal Reserve Vice Chairman Donald Kohn, who served for more than 40 years in the Federal Reserve System and is now with The Brookings Institutions, sat down with the Wall Street Journal's David Wessel to talk about what he had learned during his career.
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2013-23-19
Thursday, 19 Dec 2013 08:23 AM
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