In a testimony to the Financial Crisis Inquiry Commission, Federal Reserve Chairman Ben Bernanke said that while risk-taking, at the heart of the financial crisis, could not be entirely avoided in a dynamic economy, a framework that promoted the “appropriate mix of prudence, risk-taking, and innovation,” was needed in order to achieve both sustained growth and stability.
Touching upon the triggers of the crisis, including private and public sector vulnerabilities, Mr. Bernanke also said to the Commissions that the crisis was amplified by the problem of “too-big-to-fail” firms. He said that such firms generated a severe moral hazard, an uneven playing field between big and small firms, and endangered systemic financial stability.
By way of solution to this problem, Mr. Bernanke said, the new financial reform law and current negotiations on new Basel capital and liquidity regulations had together “set into motion a three-part strategy to address too-big-to-fail.”
This strategy included “greatly” reducing the propensity for excessive risk-taking by large, complex, interconnected firms, allowing the government to resolve a distressed, systemically important financial firm in a fashion that avoids disorderly liquidation and increasing the resilience of the system by forcing more derivatives settlement into clearinghouses and strengthening prudential oversight of key financial market utilities.
Among the vulnerabilities of the private sector Mr. Bernanke cited dependence on unstable short-term funding, deficiencies in risk management, excessive leverage, need for better regulation of derivatives.
So far as the public sector’s role in the crisis was concerned, the Fed Chairman said that the main issues related to statutory gaps and conflicts, ineffective use of existing authorities and insufficient crisis-management capabilities.