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Fed’s Kohn, Dudley Defend Size, Scope of Emergency Loan Plans
By Vivien Lou Chen
and Timothy R. Homan
April 19 (Bloomberg) -- Two of the Federal Reserve’s top policy makers
defended the Fed’s
emergency lending, saying the programs won’t cause
an inflationary surge or create “significant” risk
for taxpayers.
Vice Chairman Donald Kohn, speaking yesterday in Nashville, Tennessee,
said the Fed has loaned to
“sound” borrowers and plans to disclose
more about such credit. New York Fed Bank President William Dudley,
speaking
at the same conference, said he’s “not worried at all that” a
doubling in the central bank’s balance
sheet to $2.19 trillion will
spur inflation.
Policy makers are pursing an unprecedented strategy to revive the
economy
by providing credit to companies other than banks and cutting
the main interest rate to as low as zero. The Fed plans to
buy as much
as $1.25 trillion in agency mortgage- backed securities this year and
is providing financing for securities
backed by loans to consumers and
small businesses.
The increased credit has provoked concerns prices will surge.
Central
bank officials are “dramatically underplaying the risks and liability
side of the balance sheet,”
former St. Louis Fed President William
Poole said in an interview at the conference.
“We are very vulnerable
to an inflation explosion,” said Poole, a
senior economic adviser to Merk Investments LLC in Palo Alto,
California.
Former
Fed Chairman Paul Volcker said Congress will probably review
the authority granted to the Fed following the expansion in
its
assets.
Political Reaction
“I don’t think the political system will tolerate the degree of
activity
that the Federal Reserve, in conjunction with the Treasury,
has taken,” Volcker, head of President Barack Obama’s
Economic
Recovery Advisory Board, said in remarks to the conference at
Vanderbilt University.
U.S. lawmakers from both political
parties, including House Financial
Services Committee Chairman Barney Frank, have expressed concern in
recent months
that the central bank has overstepped its authority by
providing emergency credit.
“I think for better or
for worse we are at a point where the Federal
Reserve Act, after all that has been happening in the last year or
more,
is going to be reviewed,” Volcker said.
Central bank officials are “underestimating the political forces
they’re
going to face once the recovery starts,” said Poole, a
contributor to Bloomberg News.
Fed Vice Chairman Kohn
said in his speech “intense scrutiny” of the
central bank’s emergency programs is “natural and
appropriate.”
No ‘Fundamental Change’
Still, such attention “should not lead to a fundamental
change in our
place within our democracy,” he said. “And I believe it will not.”
While the central
bank may be channeling credit to some markets more
than others, “we are not taking significant credit risk that might
end
up being absorbed by the taxpayer,” Kohn said. “For almost all the
loans made by the Federal Reserve,
we look first to sound borrowers
for repayment and then to underlying collateral.”
Kohn made an exception
for financial institutions such as Bear Stearns
Cos. and insurer American International Group Inc. that would cause
widespread
disruption in markets should they fail. Such companies
would “probably have higher credit risk,” he said.
Kohn
said the Fed would disclose more details on its loans and
borrowers involved in central bank programs “in coming
weeks.” The
Fed’s refusal to provide such information prompted a lawsuit by
Bloomberg News in November and
criticism from U.S. Republican Senator
Richard Shelby of Alabama and other lawmakers.
Public Interest
“Understandably, given the sharp increase in loans to new institutions
and markets, the
public is naturally interested in our lending
practices,” the vice chairman said.
Dudley said he sees no legitimate
reason for rising “investor anxiety”
that participation in the $1 trillion Term Asset-Backed Securities
Loan
Facility will provoke government scrutiny.
The TALF, aimed at supporting financing of loans to credit card
borrowers,
students, car buyers and small businesses, is off to a
“slow start,” Dudley said, recording just $6.4 billion
in loans.
Investors have shied from joining some emergency credit programs after
lawmakers criticized the compensation
practices of financial companies
that accepted taxpayer funds to shore up capital, Dudley said.
Misplaced Fears
“My
own view is that these fears are misplaced,” Dudley said. He said
TALF is “completely a Federal Reserve program
and operation,” and that
government funds would only be used to protect the Fed against a
credit risk such as
a default.
Treasuries fell for a fourth week as better-than-expected earnings at
banks including Goldman Sachs Group
Inc. and JP Morgan Chase & Co.
bolstered speculation the longest recession in the postwar era may be
easing. The
yield on the 10-year note rose two basis points this week,
or 0.02 percentage point, to 2.95 percent.
In an unusual
public exchange between a current and former U.S.
central banker, Volcker asked Kohn to explain the merits of a 2
percent
inflation goal, instead of a 1 percent or 3 percent objective.
“By aiming at 2, you have a little more room on
nominal interest
rates, a little more room to react to an adverse shock to the economy
or better odds of stabilizing
the economy,” Kohn said.
Clearer Objective
“By being clearer about our objective about what we consider
price
stability, we will have armed ourselves to lean against tendencies for
inflation to rise,” Kohn said.
The
vice chairman also said that he doesn’t expect deflation, or a
consistent decline in consumer prices, over the next
five years, while
not ruling out the possibility.
The Fed’s credit programs “have helped ease financial
conditions,
though they can’t address all the problems in financial markets,” Kohn
said. “The situation
in financial markets and the economy would have
been far worse if the Federal Reserve hadn’t taken the actions.”
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