05 June 2008

Treasury Nason - Fed lending comes with 'regulatory cost'

The 'too inter-connected' assumption does not supplant market forces, Nason said. We need to develop ways to ensure that private institutions, even complex ones, can fail without threatening the real economy.

“If firms have access to a government backstop, then there must be a regulatory cost for this benefit,” Assistant Secretary David Nason said in New York.

 

“It seems clear that we need to improve how we regulate complex financial firms”, Nason said. “The traditional toolbox of monetary policy and the regulatory framework might not be well-suited to deal with transmission of financial shocks to the real economy in today's financial markets.”

 

“The most dominant force or trend compelling change is the globalization of the financial services industry”, Nason said supporting the plans to recasting and expanding the role of the Federal Reserve as a market stability regulator.

 

Public policy makers have struggled for years against the assumption that some financial institutions were ‘too big to fail’. “Now, we should consider whether certain firms are ‘too interconnected to fail’”, he said. “And, if so, what can we do to address this concern.”

 

Nason cautioned that the “too inter-connected” assumption does not supplant market forces and guarantees a backstop in general. “We need to develop ways to ensure that private institutions, even complex ones, can fail without threatening the real economy.”

 

He also warned that if market participants and supervisors cannot evaluate fully the risk profiles of the financial institutions using new financial products, then it remains unclear that innovation has reduced risk. “We should be concerned about the consequences of forcing innovation and risk-taking decline to levels below what the market would normally allow”, he said.

 

Full speech

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