Fed president: Need to prevent ‘too big to fail’

The president of the Federal Reserve Bank of Chicago says allowing financial institutions to become “too big to fail” must be addressed to prevent another financial meltdown.

Charles Evans, speaking Wednesday to business school students at the University of Iowa Pomerantz Center, said preventive policies need to be in place to eliminate what he termed a “problem,” rather than a policy.

“We need an environment where there's enough capital and an institution's loan portfolios can withstand the risks it has taken,” Evans said. “Risks need to be aligned appropriately with rewards and that's probably a tougher regulatory environment than we've had in place over a long period of time.”

Evans, in comments at the Corridor Economic Forecast Luncheon at the Coralville Marriott, said the nation's economy has moved out of recession into recovery. But he admitted that a 10 percent jobless rate and sluggish housing sector make it hard to accept for many households and businesses.

“Unemployment remains very high, and many businesses are still producing and selling much less than they did two years ago,” Evans said. “I think what people really want to know is when will we make significant progress in returning unemployment and other measures of economic health to more normal levels?

“We appear to be moving in that direction, but there is much work to be done.”

Evans said many employers are very cautious about hiring at this time, given continued uncertainty over the pace of the economic recovery.

“But I think that many businesses already are finding they can take lean production only so far,” he said. “These firms should be ready to expand permanent hiring once they see clearer signs of sustained increases in demand.”

Manufacturing activity dropped sharply as the current recession took hold in Iowa and the Midwest. Evans said it will take years for the business cycle to recover.

“It's going to be uncomfortably slow for the manufacturing sector to return to very good working conditions,” he said.

Evans said availability of bank credit remains a “significant headwind” for many small- and medium-size companies.

“At least some of the reduced lending arises from banks' tighter lending standards,” he said. “These tighter standards, in turn, appear to reflect banks' concern over their capital levels and also the credit quality of borrowers.

“I expect banking conditions to improve, but this is likely to take some time.”

Evans said restrictive bank credit, along with business and household caution, will continue to restrain the recovery's strength.

“However, I expect these headwinds to abate as we move through 2010,” he said. “We at the Chicago Fed expect gross domestic product growth to average 3 to 3 and a half percent in 2010.

“Such growth is only slightly above our estimate of the economy's potential growth rate, which means unemployment will likely decline only modestly this year.”