US officials find flaws in credit crisis response

Federal Reserve officials said authorities may have exacerbated the financial crisis by responding inconsistently and indecisively to events, and one suggested the government should be quicker to take over failing institutions.

Thomas Hoenig, President of the Kansas City Federal Reserve Bank, criticised authorities for reacting too slowly to the problems plaguing financial institutions, while the head of the Philadelphia Fed, Charles Plosser, said the Fed must be better prepared to handle the failure of some institutions.

In a harsh assessment of the government's handling of the worsening upheaval among financial institutions, Hoenig said authorities had been quick to provide liquidity and public capital to buoy struggling firms, but have not formulated a clear plan to address specific problems, including insolvency.

"We understandably would prefer not to 'nationalise' these businesses, but reacting as we are, we nevertheless are drifting into a situation where institutions are being nationalised piecemeal with no resolution of the crisis," Hoenig said in a speech in Omaha, Nebraska.

"We have been slow to face up to the fundamental problems in our financial system and reluctant to take decisive action with respect to failing institutions," he said.

Plosser, meanwhile, said the government's varied reactions to problems at major financial institutions have exacerbated market volatility. "The financial problems at Bear Stearns, AIG, and Lehman Brothers elicited different responses from government, which contributed to uncertainty. Arguably, this uncertainty in itself became a source of systemic risk," Plosser said at a conference sponsored by New York University's Stern School of Business.

The central bank should develop a clearer procedure for determining what institutions are so big that their downfall threatens the entire financial system, and how to wind them down in an orderly manner in a crisis, he said. Plosser is not a voter on the Fed's interest rate-setting committee this year.

"Failures are an inevitable consequence of a dynamic financial system," he said.

Financial authorities have come under increasing fire as hundreds of billions of dollars in loans and capital infusions into distressed institutions have failed to halt the steep economic downturn, which has accelerated in recent weeks.

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