Northern Rock Lessons for the US
The Federal Reserve's monetary policy, lender of last resort and supervisory functions are not only deeply interconnected, but essential for the Fed's role in facilitating healthy financial markets, said William Dudley, president and CEO of the New York Federal Reserve. Dudley drew a lesson from the drawn-out restructuring plans of UK mortgage lender Northern Rock to argue the Fed's roles should not be limited or separated. His comments, in a speech delivered this week at the Columbia University World Leaders Forum in New York, gave implicit support for government intervention in structured finance when he discussed keeping the federal funds rate target "exceptionally low for an extended period" to alleviate credit constraints and help securitization activity recover. Dudley urged more effective regulatory structure for the Fed in the execution of its monetary policy, lender of last resort and supervisory functions, which he said are necessary and inseparable. In order for the Fed to act effectively as lender of last resort, it must have a first-hand understanding of the banks, capital markets and payment and settlement systems, according to Dudley. But in order to fulfill this role safely, the Fed must know its borrowers. In other words, the Fed needs its monetary policy and supervisory functions in order to fulfill its lender of last resort role. Taking any one of these responsibilities away would make fulfilling the others more difficult. "One instructive example in this context is the Northern Rock experience in the United Kingdom, where banking supervision and the lender of last resort functions were separated," Dudley said. "Many have concluded that this separation led to coordination problems that delayed intervention and significantly exacerbated the crisis. The experience with Northern Rock is a cautionary lesson about the potential costs of separating banking oversight from the lender of last resort function." Her Majesty's (HM) Treasury approved a Jan. 1, 2010 date for the restructuring of Northern Rock, which aims to strengthen the firm's capital position and help it return to the mortgage market. "The Government took action to stabilize the bank two years ago, ensuring in the process that not a single customer of the bank lost any of their savings," said financial services secretary Paul Myners in a statement Tuesday. "Now we can prepare the bank for its restructuring and ensure that it plays its full role in supporting the recovery of the economy." The plan to restructure includes the splitting of Northern Rock's business into two companies, with the back book of mortgages managed separately from the bank's other business. HM Treasury said this method will facilitate the government's efforts to create a well-functioning mortgage market based on responsible lending practices and a wide range of affordable mortgages. The announcement of Northern Rock's restructuring date followed HM Treasury's Monday release of updated details on its Asset Protection Scheme (APS), which aims to facilitate the healthy functioning of UK banks, promote lending and protect taxpayers. HM Treasury’s detailed announcements mirror a migration in the US and leading industrial nations toward more transparency in government initiatives and fewer taxpayer-funded bailouts. Write to Diana Golobay.