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In his last speech as Federal Reserve Board chairman, Ben Bernanke said the central bank's steps to support wholesale funding markets were "as important, if not more important" than other actions taken during the crisis.
January 16
WASHINGTON One day after regulators in September 2008 had agreed to let Lehman Brothers fail withholding government support for the investment bank then-Federal Reserve Board Chairman Ben Bernanke and other officials with the central bank were still dissecting the decision.
"The ideal way to deal with moral hazard is to have in place before the crisis begins a well-developed structure that gives clear indication in what circumstances and on what terms the government will intervene with respect to a systemically important institution," said Bernanke, according to the transcript of the Sept. 15-16 meeting of the Federal Open Market Committee, one of many records the central bank released Friday of Fed meetings during the financial crisis.
"We have found ourselves, though, in this episode in a situation in which events are happening quickly, and we don't have those things in place. We don't have a set of criteria, we don't have fiscal backstops, and we don't have clear congressional intent. So in each event, in each instance, even though there is this sort of unavoidable ad hoc character to it, we are trying to make a judgment about the costs from a fiscal perspective, from a moral hazard perspective, and so on of taking action versus the real possibility in some cases that you might have very severe consequences for the financial system and, therefore, for the economy of not taking action.
"Frankly, I am decidedly confused and very muddled about this. I think it is very difficult to make a strong, bright lines given that we don't have a structure that has been well communicated and well established for how to deal with these conditions."
It was Thomas Hoenig, then the Kansas City Fed president and now vice chairman of the Federal Deposit Insurance Corp., who said during the discussion that the episodes proved "too big to fail" was a problem.
"I think we have come to a time in our history when we have institutions that clearly ought to be and may in fact be too big to fail. I think we tend to react ad hoc during the crisis, and we have no choice at this point. But as you look at the situation, we ought, instead of having a decade of denying too big to fail, to acknowledge it and have a receivership and intervention program that extends some of the concepts of the FDIC but goes beyond that," said Hoenig.
"Regarding how we go forward, I think we are going to have many lessons from this. Part of the problem has been very lax lending and, obviously now, weaknesses in some of the oversight. Also a history of our reacting from a monetary policy point of view to ease quickly to try to take care of the problem and, therefore, to create a sense in the market of our support has raised some real moral hazard issues that we now need to begin to remedy as we look forward in dealing with future receiverships. We are in a world of too big to fail, and as things have become more concentrated in this episode, it will become even more so."
Bernanke agreed with Hoenig and reiterated his support for "a strong, well-defined, ex ante, clear regime" in the future for dealing with market turmoil.
"But we have the problem now that we don't have such a regime, and we are dealing on a daily basis with these very severe consequences. So it's a difficult problem," said the former Fed chairman.
While Hoenig argued that the U.S. regulators had done "the right thing" in how they handled Lehman, Boston Fed President Eric Rosengren wanted to reserve judgment.
"I think it's too soon to know whether what we did with Lehman is right. Given that the Treasury didn't want to put money in, what happened was that we had no choice. But we took a calculated bet. If we have a run on the money market funds or if the nongovernment tri-repo market shuts down, that bet may not look nearly so good," said Rosengren.
"I think we did the right thing given the constraints that we had. I hope we get through this week. But I think it's far from clear, and we were taking a bet, and I hope in the future we don't have to be in situations where we're taking bets. It does highlight the need to look at the tri-party repo market, look at the money market fund industry, and look at how they're financing. There are a lot lessons learned, but we shouldn't be in a position where we're betting the economy on one or two institutions. That is the situation we were in last weekend.
"We had no choice. We did what we had to do, but I hope we will find a way to not get into this position again."
