"Dr. Doom" calls credit crisis a "global calamity"

NEW YORK (Reuters) - The Federal Reserve contributed to the “global calamity” of the subprime mortgage debt crisis by allowing credit to expand excessively and failing to spot major changes in financial markets, Wall Street economist Henry Kaufman said on Friday.

A wintry sky hangs over the Federal Reserve Building in Washington January 22, 2008. REUTERS/Kevin Lamarque

He also criticized the overhaul of the U.S. financial regulatory structure proposed by the Bush administration as too complicated and lacking in focus.

“The Fed itself has contributed largely to the current debacle by failing to properly gauge and contain credit expansion in recent decades, while simultaneously providing only tepid oversight of commercial banking,” said Kaufman, who is founder and chairman of financial consulting firm Henry Kaufman & Company, Inc.

“We should therefore not see it (the Fed) as the ready savior in the current crisis,” he added.

His remarks were in a prepared speech to a conference sponsored by The Global Interdependence Center and Drexel University’s LeBow College of Business in Philadelphia.

“The current credit crisis - with its epicenter in the U.S. mortgage market - is global news, a global calamity that might just be the most serious upheaval in American financial markets since the end of the Second World War,” Kaufman said.

Global financial institutions have so far sustained well over $200 billion of write-downs and credit-related losses, with the ailing U.S. housing market acting as a central catalyst.

He called for the creation of a Federal Financial Oversight Authority to regulate and oversee the biggest U.S. financial institutions.

Kaufman became known as “Dr. Doom” for correctly forecasting higher inflation and interest rates when he was chief economist with Salomon Brothers in the 1970s and 1980s.

The current crisis is more threatening than earlier ones that were centered in emerging markets because this one is playing out in the major economies and financial centers of the United States and Europe and the contagion can now spread via traded credit instruments, he said.

This crisis “is striking at the heart of the global economy rather than damaging its limbs,” he said.

Adding to this danger, the global markets have become much larger, more complex and less transparent, making it nearly impossible today to accurately gauge risk exposure, he said.

But the U.S. central bank failed to react to these changes in global financial markets, which have unfolded in recent decades, he asserted.

“The Federal Reserve - the primary guardian of our financial system - has not appreciated the extent to which profound structural changes in the financial markets have demanded new and different monetary policies and practices,” he said. “That failure looms large as a contributing factor in the current crisis,” Kaufman said.

The U.S. central bank’s huge additions of temporary liquidity to the banking system via new auction facilities and stepped up open market operations, amounting to some $400 billion since December, make sense, Kaufman said.

“In the midst of the current financial crisis, the Fed should indeed inject a massive volume of reserves into the markets to stabilize conditions. But monetary easing is not enough, nor will it help prevent similar recurrences,” he said, calling for more safeguards and deep reforms to enable investors to regain confidence in markets.

Kaufman questioned whether private credit rating agencies can offer meaningful and timely ratings. He recommended that the Fed, his proposed regulatory agency and other official supervisory organizations should be required to issue credit ratings for the financial institutions they supervise.

Reporting by John Parry; Editing by Kenneth Barry