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Fed's Lacker Worried About Money Market Funds

Wednesday, 16 November 2011 06:54 PM

The Federal Reserve believes U.S. banks can withstand an escalation of the European debt turmoil, but the fate of money market funds is worrisome, a top Fed official said on Wednesday.

"We've done a lot to prepare the banking sector," Jeffrey Lacker, president of the Richmond Federal Reserve Bank, told reporters after a speech. "I'm less confident about the money market funds and their ability to weather major problems at European institutions."

Bond market turmoil is spreading in Europe with Italian borrowing costs on the rise and France seeking stronger European Central Bank action to stem the accelerating sovereign debt crisis. Fed Chairman Ben Bernanke last week called on European officials to act quickly to contain the turbulence, which he said would harm in the United States if it spread.

U.S. policymakers have been working on contingency plans for a worst-case scenario should another domino fall. For its part, the Fed has learned as much as it can about banks' direct and indirect exposures, and is urging institutions to do the same, Lacker said.

"All the measures we have generally taken to promote financial stability - increasing capital, increasing their liquidity buffers - would all be useful in the event of such a problem," he said, but did not elaborate.

Fitch Ratings warned on Wednesday that it may reduce its "stable" rating outlook for U.S. banks because of contagion from problems in troubled European markets. Money market fund exposure is "considerable," Fitch said.

U.S. stocks deepened losses after the Fitch comments, with all three major indexes closing down more than 1.5 percent.

Money market funds, which manage roughly $2.7 trillion in assets, typically invest in short-term debt securities. Unlike bank deposits, they are not backed by a government insurance program.

Maintaining a stable net asset value of $1 per share has been a key selling point of money market funds, but one large fund's inability to maintain that value in the aftermath of the collapse of Lehman Brothers in late 2008 forced the Fed to act.

As nervous investors rushed to withdraw money, the Fed stepped in with emergency liquidity lines, and some money funds required millions of dollars in support from their parent firms.

Regulators are considering measures to make the funds more robust.

Another regional Fed president, Eric Rosengren, of the Boston Federal Reserve Bank, on Wednesday said Europe has the financial capacity to deal with developing issues in countries like Italy and Greece, but needs to show the political will to do so.

Rosengren would not respond directly to a suggestion that the Fed might buy Italian debt. "This is a European problem that should be addressed by European authorities," he said.

If there were a fresh European debt crisis the Fed would be prepared for more coordinated activity with the ECB, Rosengren said. "I'm not predicting a crisis," he added. He did say the U.S. economy remains at risk from financial shocks at home and abroad.



Lacker, Rosengren, and a top Fed economist offered diverging views about what and how much the Fed can do to spur anemic U.S. growth and pull down the stubbornly high unemployment rate.

The Fed cut rates to near zero almost three years ago and has bought $2.3 trillion in bonds to spur stronger recovery.

More recently, it moved to lower long-term borrowing costs by shifting its bond holdings into longer maturities. In addition, it promised to hold rates at exceptionally low levels well into 2013 to assure markets that it will be in no hurry to raise rates when the economy strengthens.

Lacker, who will be a voter on the Fed's policy-setting Federal Open Market Committee next year, said the central bank should not allocate credit to some sectors of the economy, such as housing, and not others.

The remarks show Lacker is likely to oppose any renewed effort to boost the housing sector through purchases of mortgage-backed securities, as some on the Fed advocate. Lacker declined to say whether he would dissent against a decision to expand purchases of mortgage securities.

Many analysts are betting the Fed could launch such a program early next year if the economy fails to pick up steam. Lacker suggested this would be a dangerous action, and went as far as saying he might favor legislative changes that would restrict the central bank to a portfolio made up purely of Treasury securities.

"The Fed could easily manage the supply of monetary assets through purchases and sales of U.S. Treasury securities only," Lacker told a conference at the libertarian CATO Institute.

Rosengren, in contrast, defended Fed actions to boost growth but said the central bank cannot by itself engineer a stronger recovery, noting that the U.S. fiscal problems "have increasingly limited the response we would normally expect."

But Rosengren, one of the most outspoken Fed advocates for further measures to boost growth, derided as a myth the belief that with interest rates already so low, additional activity by the Fed cannot help the economy.

"An action that reduces the unemployment rate by half a percent does not bring us close to full employment, and does not solve the country's problems, but nonetheless would perhaps create roughly 750,000 jobs that may not have been created in the absence of the action," he said.

However, a top Fed economist predicted the recovery will be slow and unemployment will decrease only slowly over coming years.

"Something's happened in U.S. labor markets that we can't overcome," St. Louis Federal Reserve Bank Research Director Christopher Waller told Reuters in an interview. "No matter what we do, recovery is going to be slow.

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The Federal Reserve believes U.S. banks can withstand an escalation of the European debt turmoil, but the fate of money market funds is worrisome, a top Fed official said on Wednesday. We've done a lot to prepare the banking sector, Jeffrey Lacker, president of the...
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Wednesday, 16 November 2011 06:54 PM
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