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Bernanke Says New Rules Will Reduce Risk of Crises

Friday, 24 September 2010 04:55 PM

Federal Reserve Chairman Ben S. Bernanke said new regulation should reduce the risk of future financial crises and called for more research on asset price bubbles, market liquidity and decision-making during panics.

“Numerous steps, both prescribed in the legislation and taken independently by regulators, will work to make our financial system more resilient to shocks,” the Fed chairman said today in a speech to economists at Princeton University. Still, the rules “do not by any means guarantee that financial crises will not recur,” he said.

The Fed chief cited tougher capital and liquidity standards for financial institutions and rules that require more derivatives to “be standardized and traded on exchanges rather than over the counter.”

Bernanke said the financial crisis exposed gaps in economics, the regulation of financial institutions and in risk management inside banks and brokers. Tougher risk management standards by both regulators and firms, improved supervision, and more stringent standards for financial strength should “reduce the risk of crises and mitigate the effects of any that do happen,” he said.

The Fed chairman didn’t comment on monetary policy in the text of his remarks. U.S. central bankers said Sept. 21 they were “prepared to provide additional accommodation if needed to support the economic recovery.” They also left the benchmark lending rate in a range of zero to 0.25 percent.

Insufficient ‘Vigor’

“Although financial markets are for the most part functioning normally now, a concerted policy effort has so far not produced an economic recovery of sufficient vigor to significantly reduce the high level of unemployment,” Bernanke said.

Central bankers drew on 19th century lender-of-last-resort theory developed by Walter Bagehot to manage a non-traditional financial panic, he said. Instead of depositors fleeing banks, short-term creditors were fleeing financial institutions such as investment banks and non-bank mortgage lenders.

Invoking emergency authority, the Fed created programs such as the Commercial Paper Funding Facility to provide hundreds of billions in credit to companies and banks after the usual channels of lending and financing broke down.

“The excessive dependence of some financial firms on unstable short-term funding led to runs on key institutions, with highly adverse implications for the functioning of the system as a whole,” Bernanke said.

Outside the System

The Fed chairman blamed the runs on a regulatory structure that didn’t encompass lenders working outside the banking system or place enough emphasis “on the detection of systemic risks.”

Fed officials have revamped their approach to systemic risk, he said. Bernanke, 56, was chairman of Princeton’s economics department from 1996 to 2002.

“We are taking an approach that is both more multidisciplinary -- making greater use of the Federal Reserve’s wide expertise in macroeconomics, finance, and other fields to complement the work of bank supervisors,” Bernanke said. Fed officials are also trying to focus on risks across the system as well as those inside individual institutions, he said.

Bernanke challenged economists to come up with better models of how investors, employers and consumers act in periods of extreme uncertainty. More work is also needed on how asset bubbles start and end, he said, and on how crises can impair liquidity.

“To obtain critically needed liquidity, firms were forced to sell assets quickly, but these ‘fire sales’ drove down asset prices and reinforced investor concerns about the solvency of the firms,” Bernanke said. “This dynamic contributed to the profound blurring of the distinction between illiquidity and insolvency during the crisis.”

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Federal Reserve Chairman Ben S. Bernanke said new regulation should reduce the risk of future financial crises and called for more research on asset price bubbles, market liquidity and decision-making during panics. Numerous steps, both prescribed in the legislation and...
Friday, 24 September 2010 04:55 PM
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