U.S. Fed staffer urges permanent crisis liquidity program

By Reuters Staff
August 21, 2009

JACKSON HOLE, Wyo., Aug 21 (Reuters) – Central banks should consider making some of their existing emergency liquidity programs permanent to minimize the stigma of accessing central bank credit, a top Federal Reserve board staffer said on Friday.

“They should consider whether some now-existing arrangements such as the Term Auction Facility and similar mechanisms, need to be adapted and made permanent, or new facilities established, so that the stigma of using central bank credit is minimized, especially in future crises,” Brian Madigan, director of the Fed’s Division of Monetary Affairs, said in remarks prepared for deliver to a conference here.

The Fed uses its discount window to lend directly to banks, but some firms are wary of tapping it on concern it will be perceived as a sign of weakness.

“The problem of discount window stigma is real and serious,” Madigan said. “The intense caution that banks displayed in managing their liquidity beginning in early August 2007 was partly a result of their extreme reluctance to rely on standard discount mechanisms.”

The TAF was introduced in December 2007 to help ease a funding crunch in the interbank market as the financial crisis gathered steam. It was aimed at making it easier for banks to borrow from the Fed anonymously and over longer periods.

Madigan also argued that central banks should have the ability to lend to important non-bank firms that are subject to bank-like runs.

“Like banks, their interconnectedness with other parts of the financial system, as well as their similarities to one another and to other types of financial institutions, makes contagion possible,” he wrote.

In addition, individual firms that are not big enough to be systemically important in and of themselves can also warrant access to central bank lending, Madigan added.

Money funds, for example, experienced bank-like runs in October 2008 as investors rushed to redeem their holdings. A number of them facing redemptions at the same time can pose a risk to the system.

“A means of lending in contingency situations even to nonbank firms that may not be systemically critical in themselves would seem necessary to promote a suitable degree of financial stability,” he said.

A regulatory regime should include a mechanism for central banks to extend credit in a crisis to entities that are not normally able to borrow from the central bank, Madigan said.

“No reasonable system of regulation can draw a bright line that cannot be crossed between banks and nonbanks,” he said.

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