Richmond Federal Reserve Bank President Jeffrey Lacker called for "demonstrably" privatizing Fannie Mae and Freddie Mac, becoming the first Fed official to publicly clash with the Bush administration's strategy of keeping them as federally backed firms.
"I would prefer to see them credibly and demonstrably privatized," Lacker said Tuesday in an interview with Bloomberg Television. He agreed with former Fed Chairman Alan Greenspan's view that the two largest U.S. mortgage finance firms ought to be nationalized, then split up and sold off.
Treasury Secretary Henry Paulson by contrast has tried to keep Fannie Mae and Freddie Mac in their current form as government-sponsored companies owned by shareholders. Lacker's remarks come as a slide in the firms' stocks and increase in their borrowing costs spur speculation the Treasury will intervene.
Lacker said financial-market turmoil shouldn't keep the Fed from raising interest rates to bring down inflation, becoming at least the fourth Fed official to make that point in the past five weeks.
"It is important to withdraw this monetary-policy stimulus in a timely way," Lacker said. "That may require us to withdraw before we are certain all of the weakness is behind us and before we are completely certain that financial markets are as tranquil as we would like to see."
Federal funds futures traders expect no change in interest rates through year's end. The Fed has reduced its main rate 3.25 percentage points over the past 11 months to 2 percent.
"I certainly don't think the federal funds rate should be any lower given where we are," said Lacker. "Monetary policy is very stimulative."
Lacker also said he would be surprised to see a large U.S. bank fail. "I am broadly confident in the ability for commercial banks to weather the storm," he said. Still, there is "substantial uncertainty" around the losses and writedowns that will result from mortgages originated in 2006 and 2007, which could cause "other shoes to drop," he added.
Lacker's comments on Fannie Mae and Freddie Mac echoed the views by some former Fed officials, led by Greenspan, that the companies' links with the federal government ought to be severed. The firms package mortgages into bonds for sale to investors. They traditionally borrowed more cheaply than private companies because of an implicit government backing.
"It was an unusually straightforward answer for a Fed official," David M. Jones, president of DMJ Advisors LLC in Denver and author of four books on the central bank, said. "There's still a debate over this issue" of addressing Fannie Mae and Freddie Mac, he said.
Paulson last month won the authority to inject capital into Fannie Mae and Freddie Mac, in legislation aimed at restoring confidence in the firms. Stocks and bonds issued by the two have since declined amid continued concern they lack sufficient capital.
Fannie Mae dropped 2.3 percent to $6.01 Tuesday, down 69 percent since the start of last month. Freddie Mac lost 5 percent to $4.17, a decline of 74 percent over the same period.
"Treasury is monitoring market developments vigilantly," spokeswoman Jennifer Zuccarelli said in a statement. "We are focused on encouraging market stability, mortgage availability and protecting the taxpayers' interests."
Lacker, 52, heads a district that is home to two of the four biggest U.S. banks, Bank of America Corp. and Wachovia Corp., both based in Charlotte, North Carolina.
A former head of research at the Richmond Fed, he alone dissented in rate votes at the Fed in late 2006, advocating higher rates to stem inflation. He votes again in 2009.
The Richmond Fed president warned in June that the Fed, by expanding its financial safety net, may prompt investors to take on excessive risk. Central bankers in March opened the discount window to investment banks and loaned $29 billion against a portfolio of Bear Stearns Cos. securities to facilitate a merger with JPMorgan Chase & Co.
Since Lacker made the June 5 speech in London, the Fed has made available the discount window to Fannie Mae and Freddie Mac and agreed to a change in the law making it easier for the central bank to loan to failed banks under government control. The Fed has also extended the availability of discount window lending to investment banks until January 2009.
Fed Bank Presidents Gary Stern and Tom Hoenig have also expressed concerns about the expansion of federal safety nets for financial institutions.
"The too-big-to-fail problem has once again gotten worse," Stern said in an Aug. 14 speech in Three Forks, Montana.
Lacker said in a separate interview with Bloomberg Radio he was wary of the Fed gaining more regulatory power. Congress, the Treasury Department and the central bank are reviewing regulation in light of the credit crunch. The Treasury has proposed giving the Fed more authority to safeguard market stability.
"Our ability to exercise independent judgment about the level of the policy rate I think is quite important," Lacker said. "I do see some merits to the argument that adding responsibilities could threaten to dilute the independence" that the Fed needs for monetary policy.
Lacker said he expects economic growth of about 1 percent over the next year, hampered by the continued slump in housing. Still, economic weakness shouldn't deter the Fed from its focus on inflation, he said. Inflation excluding food and energy prices is likely to rise to about 2.5 percent before moderating, Lacker said in his radio interview.
Lacker said consumers' expectations of inflation are "elevated" and show "fragility."
"We are still in a fairly risky situation" on the inflation front, he said.
The Fed can raise rates without impeding a credit market recovery and such a rate increase may occur sooner than many people expect, said Dallas Fed President Richard Fisher, who dissented Federal Open Market Committee votes five times this year, preferring to raise them last month.
Atlanta Fed President Dennis Lockhart said in an Aug. 15 interview he expected that "the reasonable policy debate will be around holding versus raising rates." Philadelphia Fed President Charles Plosser said July 23 that policy makers should act before inflation expectations become "unhinged."
Lacker's advocacy for an early rate increase may not prevail on the committee, according to Robert Eisenbeis, chief monetary economist at Cumberland Advisors, and former research director at the Atlanta Fed.
Lacker "saw prospects for slower growth in the future," Eisenbeis said. "Yet he was also concerned about rising inflation. I think growth is going to be the dominant concern and that's what's going to carry the day for most of the people there."