Bernanke, Buiter, Draghi Diverge on How to Forestall Crises

By Scott Lanman and John Fraher

Aug. 25 (Bloomberg) -- One year into the financial crisis, central bankers and scholars at the Federal Reserve's annual retreat this weekend couldn't agree on how to prevent a repeat.

Fed Chairman Ben S. Bernanke, European counterpart Jean- Claude Trichet, former officials and economists meeting in Jackson Hole, Wyoming, split over whether central banks should be made responsible for financial stability and how closely to heed the concerns of Wall Street.

``We shouldn't delude ourselves into thinking we are going to build a panic-proof system,'' former Fed Vice Chairman Alan Blinder, who attended the conference, said in an interview with Bloomberg Television. ``But there are choices between less and more panics, more virulent ones, less virulent ones, and that is the way we want to push the system.''

At stake is the shape of financial regulation as governments and legislators draft new laws in response to the crisis, which stemmed from a collapse in U.S. mortgage bonds and has sparked more than $500 billion in losses and writedowns. Too many new rules may hobble financial innovation, while a hands- off approach could create more bubbles after a series of asset- price busts over the past decade.

Bank of Israel Governor Stanley Fischer said in a speech closing the two-day conference in the Teton Mountains that ``it didn't settle a whole lot.''

Defending Record

Participants, greeted by a stuffed 600-pound (272 kilogram) grizzly bear as they entered the Jackson Lake Lodge's wood- paneled meeting room, heard Trichet and Fed Governor Frederic Mishkin defend the track record of central banks over the past year. Critics such as academic Willem Buiter countered that their willingness to bail out distressed investors is ``unhealthy and dangerous.''

``You want to keep the baby in the bathwater, so to speak, but throw out the bathwater,'' former International Monetary Fund chief economist Raghuram Rajan said in an interview with Bloomberg Television. ``That's going to be a very hard thing.''

Rajan and two co-authors presented a proposal at the symposium for disaster insurance that gives banks access to capital when they suffer big losses on their loans.

The conference is the central-banking community's hottest ticket, hosted by the Kansas City Fed bank in Grand Teton National Park since 1982.

Attendees heard Bernanke signal in his opening speech Aug. 22 a need for new Fed powers and comprehensive supervision of systemic risk. Senior U.S. lawmakers, such as House Financial Services Committee Chairman Barney Frank, advocate giving the Fed authority to supervise investment banks.

Inflation Concern

A few hours later, European Central Bank governing council member Mario Draghi, who chairs an international group of regulators and finance officials, said policy makers additional responsibility for ensuring stable markets would risk impeding their ability to control inflation.

Participants nevertheless agreed that change is on the way, even if its form is as yet unclear. Pippa Malmgren, a former financial-markets adviser to U.S. President George W. Bush, said firms' capital and liquidity requirements are likely to increase, making it tougher for them to generate profits on the scale they have in the past.

`They're going to take the keys to the Maserati away,'' said Malmgren, now president of London-based adviser Canonbury Group. ``This is going to dramatically change the financial landscape.''

Faulting Fed

The event's biggest debate was sparked by Buiter, a former Bank of England policy maker, who presented a paper saying the Fed pays too much heed to the concerns of financial institutions. In response, Blinder, now professor of economics at Princeton University in New Jersey, said the central bank's performance, though not flawless, has been ``pretty good'' given the magnitude of the crisis.

Trichet also came to the Fed's defense, saying ``what has been done until now has been pretty well done under very difficult circumstances.''

While lawmakers and regulators will be busy trying to figure out how to write new rules, how any expansion of the Fed's authority works in practice may be out of the central bank's control, said Carnegie Mellon University professor Allan Meltzer, who is writing the second volume of a history of the Fed.

``Lawyers and bureaucrats make regulation, and markets decide how to circumvent them,'' Meltzer said during an audience discussion period.

One thing attendees did agree on: The yearlong credit crisis has yet to run its course, with continued turmoil likely in housing and banking. Martin Feldstein, a Harvard University economist, said he expects ``some failures in the regional banks, including some big regional banks.''

``It was clear from what was said that most people here don't believe the financial crisis is necessarily over or close to being over,'' Fischer said in his closing speech.

To contact the reporters on this story: Scott Lanman in Jackson Hole at slanman@bloomberg.net; John Fraher in Jackson Hole, Wyoming at jfraher@bloomberg.net