Fed's Hoenig Says Institutions Must Be Allowed to `Fail'

By Anthony Massucci and Bill Faries

Sept. 1 (Bloomberg) -- Federal Reserve Bank of Kansas City President Thomas Hoenig said for economies to work best, institutions must be allowed to `fail.'

Economies must ``find a balance between financial stability and a stable price environment and in doing so must be able to allow individual institutions to fail,'' Hoenig said in a speech today in Buenos Aires.

Turmoil in financial markets has persisted, even after the Fed started and expanded emergency programs to lend to commercial and investment banks. Changes in financial markets combined with the subprime-mortgage crisis have ``raised anew questions about the role of central banks in maintaining financial stability,'' he said.

The subprime-mortgage collapse has taken a toll on banks and other financial companies, which have reported $514 billion of writedowns since the start of 2007. The Fed rescued Bear Stearns Cos. from bankruptcy in March, facilitating the firm's merger with JPMorgan Chase & Co. by lending against $29 billion of Bear securities.

``Financial crises will occur despite our best efforts to prevent them,'' Hoenig said in prepared remarks at an event hosted by Argentina's central bank. ``The `Too Big to Fail' issue will only grow in importance as the consolidation of the financial industry grows in both size and scope in future decades.''

Hoenig didn't comment on the U.S. economic outlook or monetary policy in his remarks.

Job Losses

About 463,000 Americans have lost jobs since January as the worst housing recession in a quarter century has curtailed spending and bank lending. Economists expect annualized rates of growth of 1 percent in the third quarter and 0.4 percent in the fourth quarter, according to the median estimate in a Bloomberg Survey in early August.

Earlier today, Federal Reserve Governor Randall Kroszner said the U.S. housing slump and financial turmoil have rippled to global emerging markets, slowing growth and bringing stock market declines.

The Fed said Aug. 11 in a quarterly survey that more banks tightened lending for homes, small businesses and credit cards. About 75 percent of U.S. banks indicated they raised standards on prime mortgage loans, up from 60 percent in the previous survey, the central bank said.

Federal Reserve Chairman Ben S. Bernanke said on Aug. 22 that financial turmoil has ``not yet subsided,'' and is contributing to weaker economic growth and higher unemployment. Policy makers will ``continue to review'' the Fed's measures to ensure liquidity to determine ``if they are having their intended effects,'' Bernanke said.

Hoenig, 61, dissented from a rate cut on Oct. 31 because of inflation concerns. Hoenig doesn't vote this year and will vote next in 2010. Dallas Fed President Richard Fisher has dissented from Federal Open Market Committee votes five times this year, preferring to raise interest rates last month.

To contact the reporter on this story: Anthony Massucci in New York at amassucc@bloomberg.net; Bill Faries in Buenos Aires wfaries@bloomberg.net

Last Updated: September 1, 2008 14:53 EDT

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