Financial system health depends on the return of market discipline, Federal Reserve Bank of Richmond president Jeffrey Lacker said yesterday.
“A healthy, well-functioning financial system requires a restoration of market discipline, and that will be impossible without clear boundaries on the federal financial safety net,” Lacker told the Institute of International Bankers, according to prepared text of his remarks released by the Fed.
“True, regulation and supervision needs strengthening, and that process is well underway at the Federal Reserve and elsewhere,” he said. “But merely expanding the scope of regulation to chase those firms that extract implicit guarantees by engaging in maturity transformation would be an interminable journey with yet more financial instability in its wake.
“Arresting the continual expansion of the implicit safety net will in turn require changing what people believe about the likelihood of government support in the event of a future crisis.
“Having experienced two years of dramatic safety-net expansion, reconditioning beliefs will be a difficult process,” he continued.
“It will require writing clear rules that constrain the use of public funds. But it also will require that the rules be confirmed by future behavior, and this will be the greatest challenge to achieving real financial reform.”
