Kohn worried about weight of expectations on Federal Reserve

US not as well placed as UK to tackle another crisis, says former Fed vice-chair

Donald Kohn speaking to Christopher Jeffery at the Central Banking Awards dinner in London, 2017

The world’s most important central bank, the US Federal Reserve, may fall short of public and market expectations in the event of an economic and financial meltdown of similar proportions and scope to the global financial crisis, according to one of its top former policymakers.  

“The Fed has done a terrific job in requiring much more bank capital and liquidity, focusing on the systemically important financial institutions and making sure they are well capitalised. But it has essentially no authority outside of the banking system,” said Donald Kohn, former vice-chair of the Fed, during an interview on stage at the Central Banking Awards 2017 dinner in London.

Kohn told attendees he is concerned that people “look to the Fed” as “the logical organisation that should be responsible for financial stability”. As a result, “if things go wrong, they will blame the Fed – but the Fed doesn’t really have the tools and instruments to deal with everything that could go wrong”.

Financial stability in the US is handled by the Financial Stability Oversight Council, a unit under the Treasury that has representatives from the Fed, other federal financial regulators, state regulators and an independent insurance expert appointed by the US president.

Kohn – a 40-year veteran of the Fed, who was vice-chair during the financial crisis, became a founding member of the Bank of England’s (BoE) Financial Policy Committee in 2011 – has the relatively rare experience of holding senior posts at more than one major central bank. And his assessment of the US financial system is not favourable.  

“The thing that is really lacking are countercyclical residential real-estate tools,” said Kohn. “If you look at financial stability cycles in the US or UK, a lot of them have to do with houses, mortgages and consumer household borrowing.”

This means that while efforts have been made in the US to make the system “a little safer and more stable, structurally”, Kohn said that “nobody is even talking about what to do if you see another bubble and standards slipping”: “How would you act? What tools would you use? Could you put a limit on loan-to-value ratios the way many countries have done with loan-to-income ratios.”

“That is not even part of the discussion, and I think the US has some way to go on this,” said Kohn, adding that while “huge strides” have been made, the US is “not as far along as the UK”.

Kohn, who made the comments after being presented with Central Banking’s Lifetime achievement award, also spoke about how he ended up working initially at the Federal Reserve Bank of Kansas City – rather than the New York Fed – and his experiences working with former Fed chairs Paul Volcker, Alan Greenspan and Ben Bernanke, as well as former BoE governors Eddie George and Mervyn King, and with incumbent BoE governor Mark Carney.

He also shared his experiences working to tackle the global financial crisis, as well as revealing if he had any major regrets about the policy decisions taken in the lead-up to and during the crisis. He attempted to reason through the logic of the Trump administration with regard to monetary policy tightening and potentially rolling back some aspects of banking regulations.

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