Fed’s Lacker: Expansion in Fed Lending Creates Instability

The recent expansion in Federal Reserve Lending to financial markets has extended well beyond the boundaries of supervision, creating instability and uncertainty for all, said Federal Reserve Bank of Richmond president Jeffrey Lacker, at a conference on monetary policy Wednesday.

While efforts to mitigate overall damages of financial turmoil is clearly understandable, said Lacker, such widespread lending can create the expectation that similar support will always be available. “Such expectations can themselves be very costly, because they can distort the incentives faced by, and as a result, the choices made by private-sector participants,” he said.

Lacker said boundaries must be placed on the safety net that has been provided to financial market participants, now that the old boundaries have been wiped out. “In doing so, the prime directive should be that the extent of regulatory and supervisory oversight should be commensurate with the extent of access to central bank credit in order to contain moral hazard effectively.”

He stressed the importance of a placing boundaries in a way that is “time consistent” — a “credible” commitment not to provide support beyond the new policy boundaries.

In his speech, Lacker also said he didn’t believe that bank capital problems were the leading cause of the sharp reduction in lending.  “My reading of current conditions is that bank lending is constrained more now by the supply of creditworthy borrowers than by the supply of bank capital,” he said.

Lacker joins a number of other Fed presidents who have recently expressed concern with the dramatic expansion of central bank lending.

“This panoply of lending facilities bears little resemblance to the classic textbook image of the Fed’s discount window in normal times,” said Philadelphia Federal Bank president Charles Plosser, according to the Pittsburgh Post-Gazette. “It doesn’t even look similar to the kind of lending activities we did during the Great Depression.”

Plosser condoned the Fed’s actions due to the scope of today’s global turmoil, but he worries too, that returning to the bank’s core mission — price stability — will be problematic.

Write to Kelly Curran at kelly.curran@housingwire.com.