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Friday, August 22, 2008

Bernanke Urges Haircuts for Creditors When Investment Banks Fail

by Calculated Risk on 8/22/2008 02:56:00 PM

Fed Chairman Bernanke's urged changes in the financial structure in his speech this morning.

First, Bernanke pointed out the moral hazard in bailing out Bear Stearns:

As you know, in March the Federal Reserve acted to prevent the default of the investment bank Bear Stearns. ... [T]hose events also have consequences that must be addressed. In particular, if no countervailing actions are taken, what would be perceived as an implicit expansion of the safety net could exacerbate the problem of "too big to fail," possibly resulting in excessive risk-taking and yet greater systemic risk in the future. Mitigating that problem is one of the design challenges that we face as we consider the future evolution of our system.
Bernanke suggested that regulatory and statutory changes need to be made so that the Fed can wipe out the equity holders and give haircuts to some creditors when critical nonbanks fail:
A statutory resolution regime for nonbanks, besides reducing uncertainty, would also limit moral hazard by allowing the government to resolve failing firms in a way that is orderly but also wipes out equity holders and haircuts some creditors, analogous to what happens when a commercial bank fails.
emphasis added