Kroszner: U.S. Consumers Face Challenges

Monday, October 20, 2008 3:23 PM

U.S. consumers face many challenges as equity price falls hit retirement accounts and home values suffer big losses, Federal Reserve Governor Randall Kroszner said Monday.

Given this "negative wealth effect," Kroszner said it was "important to think about what the government can do to support economic activity," which is heavily dependent on the pace of retail spending.

Answering questions after a speech to the Risk Management Association meeting in Baltimore, Kroszner fell short of endorsing a second federal stimulus plan to help the U.S. economy overcome the effects of the global financial crisis.

Earlier on Monday, Fed Chairman Ben Bernanke threw his support behind a second stimulus plan in remarks to a congressional panel.

The initial series of tax rebate checks mailed to millions of Americans in the spring gave retail spending a shot in the arm that has since faded. Retail sales fell 1.2 percent in September, their largest monthly decline since August 2005.

Kroszner did not comment on the outlook for interest rates in his prepared remarks, which focused on the likely fallout from the biggest financial crisis since the Great Depression.

Financial markets are confident the Fed will lower interest rates again at its next monetary policy meeting on Oct. 28-29, most likely by one-quarter percentage point to 1.25 percent.

Kroszner said the Fed would use all its tools to "improve market functioning and liquidity, to reduce pressures in key credit and funding markets, and to complement the steps the Treasury and foreign governments will be taking."

Banks should brace for a new push to strengthen U.S. financial industry regulations and be ready to operate in whatever climate emerges, Kroszner told an audience of financial professionals.

More broadly, the policy-maker argued for a top-to-bottom review of risk management practices, from how to operate in a less leveraged environment to the dangers of tying compensation too much to short-term performance factors.

Business in the post-credit-crunch world will be driven by a greater focus on funding and liquidity, with risk management restored to a prime position, he said.

Financial firms may also seek to lower risks by shifting more of their business to organized exchanges backed by clearing houses, Kroszner said.

"An exchange that has a centralized counterparty ... can reduce uncertainty about counterparty risk and help to avoid market dislocations that can arise from such uncertainty."

Some institutions might gravitate more to "traditional, 'bread-and-butter banking,' with exposures and risks tied more closely to bank balance sheets, he said.

The financial market meltdown, in spreading to almost every corner of the globe, has shown that operating in multiple geographic markets does not limit risk, Kroszner said.

"Uncertainty, fear, and lack of trust among key counterparties can dramatically affect trading in some products across markets in many countries," he said.

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