Bailouts unconscionable and must end: Bernanke

He says fate of world economy must never be so closely tied to fortunes of a relatively small number of giant firms again

22 March 2010

Federal Reserve chairman Ben Bernanke said that government bailouts of big financial companies are ‘unconscionable’ and must be ended as part of a regulatory overhaul following the worst financial crisis since the 1930s.

‘It is unconscionable that the fate of the world economy should be so closely tied to the fortunes of a relatively small number of giant financial firms,’ Mr. Bernanke said last Saturday in a speech in Orlando, Florida. ‘If we achieve nothing else in the wake of the crisis, we must ensure that we never again face such a situation.’

Congress is considering a resolution mechanism for financial firms that are so large or interconnected to other institutions that their failure could damage the financial system.

Resolution mechanism

A plan by Senate Banking Committee chairman Christopher Dodd, a Connecticut Democrat, would allow the Federal Deposit Insurance Corp to liquidate a large firm after a panel of bankruptcy judges determines that the company is insolvent and with approval of the Fed, FDIC and Treasury Department.

The Fed chairman has faced criticism from Congress for bailouts that he said were intended to prevent a possible depression. Lawmakers including Mr. Dodd have criticised the Fed’s purchase of US$29 billion of securities in March 2008 to facilitate the merger of Bear Stearns Cos with JPMorgan Chase & Co, and loans to keep American International Group Inc from default.

All large financial firms rather than just big banks should be subject to stronger regulation, Mr. Bernanke told bankers gathered for the Independent Community Bankers of America convention. Shareholders and creditors should not be protected from losses in any plan, he said.

The Fed is revamping its approach to supervision of large banks, using economists and quantitative analysts to help with horizontal reviews targeting risks across the financial system, Mr. Bernanke said.

‘We at the Federal Reserve have been working with international colleagues to require that the most systemically critical firms increase their holdings of capital and liquidity and improve their risk management,’ he said.

The Fed chief also endorsed the concept of financial firms having ‘living wills’, or plans on how to unwind should they become insolvent. Mr. Dodd’s proposal includes a provision that requires large, complex companies to periodically submit ‘funeral plans’ for their quick and orderly shutdown in the event of failure.

‘An idea worth exploring is to require firms to develop and maintain a so-called living will, which will help firms and regulators identify ways to simplify and untangle the firm before a crisis occurs,’ Mr. Bernanke said.

While the FDIC has the power to take over failing deposit-taking firms and wind down assets, no such authority exists for financial firms that aren’t classified as banks, such as AIG or a hedge fund with extensive links throughout the banking system.

The Fed chairman also defended the central bank’s structure, including 12 regional banks, as a useful decentralised network to monitor the financial system and economy. He said that the oversight of small banks has been critical to the Fed in setting monetary policy.

‘A supervisory agency that focused only on the largest banking institutions, without knowledge of community banks, would get a limited and potentially distorted picture,’ he said.


Answering questions after his speech, Mr. Bernanke urged community bankers to help keep the central bank informed about changes in finance and the economy.

‘We greatly value the input and information we get from community banks all across the country,’ he said. ‘In the current crisis, understanding commercial real estate, understanding other problems in credit markets is greatly aided by knowing what’s happening in community banks.’

John Bowman, acting director of the Office of Thrift Supervision, called last Saturday for the creation of a federal agency to supervise community banks and thrifts.

‘Whether a community bank holds a state charter, a national bank charter or a federal thrift charter, that institution should not be supervised by the same agency that oversees complex commercial banks,’ Mr. Bowman said in a speech to the conference, according to an OTS release.

Mr. Bernanke and Fed bank presidents are fighting efforts from Congress to shrink the Fed’s role in bank supervision. Mr. Dodd proposed that the Fed’s supervisory authority include only bank holding companies with more than US$50 billion in assets, while the Federal Deposit Insurance Corp and the Office of the Comptroller of the Currency would regulate other banks. A Bill passed by the House of Representatives in December left the Fed’s current supervisory authority intact.

The Fed oversees about 5,000 bank holding companies and more than 800 state member banks. The Board of Governors in Washington delegates supervisory authority to the regional Fed banks which have examiners on staff.

Smaller bankers are on the ‘front line’ of coping with aftershocks from the financial crisis, including ‘high unemployment, lost incomes and wealth, home foreclosures, strained fiscal budgets’, Mr. Bernanke said.

The central bank chairman didn’t comment directly on the economy or outlook for monetary policy in his remarks.

The Fed has kept the federal funds rate target for overnight loans between banks in a range of zero to 0.25 per cent since December 2008. Policy makers began using the ‘extended period’ language in March last year and have repeated it at each meeting since then.


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