The Fed official who played a major role in the bailout of failed investment bank Bear Stearns now says such banks should meet the same capital requirements as regular commercial banks.
If implemented, such a policy would cut leverage substantially. In turn, although losses would be lower in bad times, profits, too, would suffer in good times.
"The institutions that play a central role in money and funding markets — including the main globally active banks and investment banks — need to operate under a unified framework that provides a stronger form of consolidated supervision, with appropriate requirements for capital and liquidity," New York Federal Reserve Bank President Tim Geithner writes in a Financial Times opinion piece.
To effect that change requires more regulation.
"We need to put in place a stronger framework of oversight authority over the critical parts of the payments system," Geithner argues, "not just the established payments, clearing and settlements systems, but the infrastructure that underpins the decentralized over-the-counter markets."
And who should be the leader in enforcing this regulation in the U.S.? The Fed, according to Geithner.
"Because of its primary responsibility for the stability of the overall financial system, the Federal Reserve should play a central role in such a framework, working closely with supervisors in the U.S. and other countries," he writes.
"At present the Fed has broad responsibility for financial stability not matched by direct authority, and the consequences of the actions we have taken in this crisis make it more important that we close that gap."
The Fed’s establishment of facilities to lend directly to investment banks for the first time in more than 70 years saved the financial system from a meltdown during Bear Stearns’ failure in March, according to Geithner.
"The Fed has put in place a number of innovative new facilities that have helped ease liquidity strains," Geithner writes.
"We plan to leave these in place until conditions in money and credit markets have improved substantially. Some of these could become a permanent part of our instruments. Some might be best reserved for the type of acute market illiquidity experienced in this crisis."
More supervision is also necessary for institutions outside the Fed’s purview, such as hedge funds and private equity firms, Geithner maintains.
"I do not believe it would be desirable or feasible to extend capital requirements to leveraged institutions such as hedge funds," he writes.
"But supervision has to ensure that counterparty credit risk management in the supervised institutions limits the risk of a rise in overall leverage outside the regulated institutions that could threaten the stability of the financial system."
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