The nation's economic disaster has forced regulators to try new ideas and make quick decisions to stabilize markets, while not stifling innovation and competition, the president of the Federal Reserve Bank of Philadelphia said Thursday.
"In general, I would argue against making major policy reforms in the heat of battle because doing so risks adopting policies that have unintended consequences," Charles Plosser told the Economic Club of Pittsburgh at the Omni William Penn Hotel. "Such quick fixes may inadvertently hamper market competition or innovation and create conditions that may provide the foundation of the next crisis."
But Plosser admitted that there was no plan in place to tell officials at the Federal Reserve, the Securities and Exchange Commission or the Federal Deposit Insurance Corp. how to handle the recent failures of major financial firms.
The job of regulators is to prevent problems at one bank or financial company from spilling over to other healthy institutions, and posing a risk to the financial system as a whole, he said.
Plosser pointed to the collapse of investment banking firms Bear Stearns and Lehman Brothers, and the government seizure of insurance giant American International Group, or AIG, as examples.
"Serious funding problems at Bears Stearns happened extraordinarily quickly," Plosser said. Looking at how intertwined the company was with other financial firms, "we made a judgment call."
The solution was to agree to JPMorgan Chase's take over of Bear Stearns, with $29 billion in aid from the federal government.
"Once Bear fell, it exposed weaknesses in other entities," Plosser said. Lehman Brothers' problems had been known for some time, and when the private sector didn't come forward, the Fed and the Treasury Department refused to commit public funds.
"The judgment was that its failure posed less systemic risk," Plosser said.
AIG, like Bear Stearns, came up suddenly and again, because AIG was connected to so much of the financial system, the call was to bail out the insurance giant.
"In hindsight, some have criticized these decisions, but at the time it was a reasonable judgment," according to Plosser.
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