Economist Kaufman says Fed failed as regulator

The following appeared on page 20 in the Monday April 14, 2008 issue of the Financial Times.

By Aline van Duyn in New York

Henry Kaufman, the distinguished Wall Street economist, has added his voice to the debate about the Federal Reserve’s role in the credit crisis, saying the central bank failed to give enough importance to its role as a regulator.

In a video interview with the Financial Times, Mr Kaufman criticized the Fed’s monetary policy. He said it allowed too much credit expansion over the past 15 years and that this contributed to the market turmoil.

“Certainly the Federal Reserve should shoulder a substantial part of this responsibility…it allowed the expansion of credit in huge magnitudes,” Mr Kaufman said.

“Besides its monetary policy approach, [the Fed] really indicated very clearly that it was performing its role as a supervisor…in a minute fashion, not in an encompassing fashion. Monetary policy had a high priority, supervision and regulation within the Fed had a smaller policy.

Mr Kaufman, who is on the board at Lehman Brothers, has long advocated tougher regulation of the biggest financial firms, arguing that they need to be made “too good to fail”, rather than remain “too large to fail”.

The near-collapse of Bear Stearns last month, and the Fed’s intervention which resulted in a purchase of the Wall Street firm by JPMorgan Chase, has triggered a renewed debate about whether banks can regulate themselves, or whether regulators need to impose tougher rules.

The credit crisis, which stems from losses on securities backed by risky mortgages made during the height of the housing bubble, could lead to total writedowns of nearly $1,000bn for banks and investors around the world, according to the International Monetary Fund.

Mr Kaufman said a distinctive feature of the financial crisis was “much greater lapses in official supervision and regulation than in earlier periods”.

He said there should be a new federal regulator appointed who would work with the Federal Reserve but who would have responsibility for “intensively” regulating the 30 or 40 biggest financial firms. Failure to do so could lead to a “crisis that’s bigger than the one which we have today”.

“The supervision of major financial institutions requires deep skills in credit, deep skills in risk analysis techniques and it requires within that organization, very skilled, trained professional people,” Mr Kaufman said. “That is lacking in the supervisory area in the United States.”

He added that recent proposals from Hank Paulson, secretary of the US Treasury, to overhaul US regulation “lack focus”.