Deleveraging still far from over: Fed's Dudley

The U.S. Federal Reserve is prepared to do whatever it takes to keep markets working, but there is more pain ahead as deleveraging is still "far from complete", a top Fed official said on Friday.

"I don't want to give you the impression that all will be well soon, that seems unlikely," New York Federal Reserve Bank President William Dudley said in a speech to the Council on Foreign Relations.

"It will take time for the deleveraging process to come to an end and, as the recent employment data have underscored, the economy has considerable momentum to the downside."

"The Federal Reserve is prepared to do whatever it takes, within the bounds of its legal authority, to keep markets working and credit available and affordable," said Dudley, who is a voting member on the Fed's policy-setting committee.

Answering questions from the audience after his speech, Dudley said there was no "magical number" at which the Fed's balance sheet would become too large.

But, he said, buying long-term Treasury securities might not be the best step for the central bank to take at this time. "Judging from the Fed's action, the Fed has judged buying long-term Treasuries is not the most efficient means of easing financial market conditions," he said.

Asked about the looming supply of U.S. debt to fund the government's economic rescue programs, he said there was still "plenty of appetite" for U.S. debt both at home and abroad, noting the global nature of the crisis.

"If not the U.S., where else?" he said.

"TOO BIG TO FAIL" LESSONS

Dudley also addressed the lessons to be drawn from the financial crisis, in a week in which the government bailout for insurer American International Group was revised.

"If large systematically important institutions are indeed too big to fail then there needs to be an explicit quid pro quo for this," he said.

"Important institutions cannot be allowed to stay outside in the sun during good times but be allowed to come inside the regulatory net when it is raining."

He said ad hoc responses to tackling the crisis "increases uncertainty and reduces policy-maker credibility."

He also called for a systemic regulator "that has both the responsibility and the powers to look across the entire financial system, both depository institutions and the capital markets." In response to a question from the audience, he said it was up to Congress to decide who this systemic regulator would be.

Dudley, who before being promoted to the top job at the New York Fed was head of the bank's markets group, said a number of the Federal Reserve's emergency initiatives including the Commercial Paper Funding Facility (CPFF) and the Term Securities Lending Facility (TSLF) have made a difference.

"The areas where the Federal Reserve and Federal governments have responded in force are doing somewhat better," he said. "Banks and dealers have plenty of access to liquidity."

The Fed on Tuesday laid out plans for a program, known as the Term Asset-Backed Securities Loan Facility (TALF), to spur consumer lending, in a program that could grow to $1 trillion. Dudley said the next version of the program would broaden the TALF into new asset classes such as commercial mortgage backed Securites (CMBS).

"In principle," he said, the TALF "could be applied to other distressed asset classes, it could move down the credit spectrum to lower-rated tranches and it could be used to fund older vintage assets."

He said the stress testing of banks should also help. Banks should end up with sufficient capital to weather an adverse environment and investors should regain confidence that the banking system will remain resilient, Dudley said.

He said the government is committed to supplying whatever capital is needed to "ensure that all the major banks remain viable."

The Public Private Investment Fund, which would buy illiquid assets, should help put a floor under the prices of these assets, Dudley said.