Donald Kohn, vice chairman of the Federal Reserve, discussed the lending industry and downside risks to the economy in remarks this morning. Where he sees the most risk however, is not clear. According to CNBC:
Banks have become so wary about lending that credit costs are being pushed up despite sharp cuts in official interest rates and that is adding to the risks of an economic downturn, the vice chairman of the Federal Reserve said Thursday.
"It is this tightening that is accentuating the downside risks for the economy as a whole," he added.
Kohn however, also spoke of another downside risk- undercapitalization:
All banks — large and small — need to consider whether they need greater capital cushions," Kohn told a credit market symposium sponsored by the Richmond Federal Reserve Bank.
"Not only would more capital provide a cushion against the sorts of unexpected declines in creditworthiness and asset values that have marked recent months, it would also position banks well for expansion," he added.
Kohn said regulators will need to ensure that minimum capital requirements and liquidity management plans are adequate to prevent shocks to the banking system from turning into broader threats to the economy.
He said he had no "ready answers" but suggested that in the future banks will likely operate with much less leverage than they were before the current credit crisis hit, and that will help create a much more stable financial system.
Banks are tightening in large part to reduce leverage and increase capital. Clearly the tightening poses a risk, but so does a failure to maintain adequate capital- it is difficult to do both. So where is Kohn putting his priorities?
Apparently I’m not the only one wondering where the Fed sees the greatest downside risk. In a Google news search for "Kohn federal reserve" this morning, the wide variety of headlines indicate that the media has a number of different takes on this morning’s speech: [CNBC's headline was the noncommital, "Bank Jitters About Lending Hurt Economy: Fed's Kohn"]
Certainly tighter lending by lenders and insufficient capital reserves both pose their own risks to the economy, but it is difficult to attack one problem without exacerbating the other. It would be nice to know where the Fed’s priorities lie.
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Twist do you find as fascinating as I do, that we have been getting a lesson on finance and banking that would never have been possible but for the “Men Behaving Badly (and Women)”. They have so messed things up that even the more obscure lending and finance practices have been exposed, like Auction Rate loans, derivatives, SIVs etc.
It boggles my mind how deep this thing is boring through the finance sector. This is why the press has no clue how to report on things related to and I believe why Wall Street views bad news as good (as long as it is in small doses).
Metro-
John started telling me about the dangers of “alphabet soup” back in the summer of 2006, and it took me awhile to figure out what he was talking about. When I did, [No, I don't think I really "grok" it all, but that's OK, Warren Buffet says he doesn't either.] I thought he was right- all of these products could really play havoc with the economy years from now.
The problems have played out faster than I ever thought they could, and now instead of chatting with friends and saying “How about them Suns!” it seems like we’re saying “So how about Lehman and Merrill, will they hold up better than Bear?”
Of course, that might now be indicative of the economy- maybe it says something about my friends!
Good use of grok (did Warren Buffet use the word?).
Are you ever right, I was at a party last week and for the first 1/2 hour it was all about the housing crash, Bear Sterns and the Fed. All of the sudden regular folks are starting to get it.
For years I sounded like I was crazy to those same people and now I am the quiet one in the room. I have only been blogging about it since 2003. Under the name metroplexual since 2005.