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Fed's Kohn Defends Policies, Says Credit Risks Generally Small

By Michael R. Crittenden and Jeff Bater, Of DOW JONES NEWSWIRES

WASHINGTON -(Dow Jones)- The credit risks taken on by the Federal Reserve during the financial crisis have generally been "very small" and in line with normal risk-taking by central banks, a top Fed official said Thursday.

Fed Vice Chairman Donald Kohn, appearing at the Brookings Institution in Washington, acknowledged that the Fed did have to take on higher levels of credit risk with the rescue of American International Group Inc. (AIG), its dealings with Bear Stearns Cos., and in other instances. But while those decisions were "very uncomfortable," they were not the status quo, he said.

"The credit risks we're taking are very, very small and in the nature of the traditional risk that central banks take," Kohn said.

Broadly, he said it was essential that the public continues to have faith in the central bank and that the Fed is committed to instilling that confidence.

Discussing interest rates, Kohn said he doubts that short-term interest rates will rise much given the weakness of the global economy. Responding to a paper analyzing U.S. monetary policy during the financial crisis, he disputed a suggestion the central bank's credit policies, combined with payment of interest on reserves, could bring adverse implications for its ability to conduct sound monetary policy.

"This outcome seems extremely remote," he said in his remarks. "The Federal Reserve's exposure to credit losses is quite limited."

Kohn said short-term interest rates would have to rise "very high, very quickly" for interest on reserves to outweigh the interest the Fed is earning on its longer-term asset portfolio.

"With the global economy quite weak and inflation low, a large and rapid rise seems quite improbable," Kohn said.

-By Michael R. Crittenden and Jeff Bater, Dow Jones Newswires; 202-862-9273; michael.crittenden@dowjones.com

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  09-10-091916ET
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