Moral Hazard and Fed Lending to Securities Firms

by Erin McCune on June 6, 2008

in Regulatory Environment

The debate over the Federal Reserve's actions to address financial panic intensified yesterday as Jeffrey Lacker, Richmond FR Bank President, warned against the danger of encouraging further risk taking:

Excerpt from Bloomberg

“The danger is that the effect of the recent credit
extension on the incentives of financial-market participants
might induce greater risk taking,'' Lacker said in a speech to
the European Economics and Financial Centre in London. That “in
turn could give rise to more frequent crises,'' he said.    

Lacker urged that the central bank now “clearly'' set
boundaries for its help to financial markets. In an interview
yesterday on the themes of his speech, Lacker said even those new
boundaries may not be believed by investors unless a financial
firm fails “in a costly way.''    

The remarks are the strongest warning by an official about
the consequences of the Fed's aid to securities dealers, the
first lending to nonbanks since the Great Depression. While other
regulators have focused on tightening investment-bank oversight
in exchange for the lending, Lacker said there's a case for
“scaling back'' the new programs.

Full text of Lacker's speech in London

More coverage in The Wall Street Journal

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