Former Bank of England policy maker Willem Buiter sparked the biggest debate at the Federal Reserve's annual mountainside symposium, saying the central bank pays too much heed to the concerns of financial institutions.



''The Fed listens to Wall Street and believes what it hears,'' Buiter said in a paper presented to the Fed's conference in Jackson Hole, Wyoming. ''This distortion into a partial and often highly distorted perception of reality is unhealthy and dangerous.''



Fed Governor Frederic Mishkin said Buiter's paper fired ''a lot of unguided missiles,'' and former Vice Chairman Alan Blinder ''respectfully disagreed'' with his analysis of the central bank's crisis management. Bank of Israel Governor Stanley Fischer told the gathering a fire extinguisher might be needed to cool the dispute.



The Fed has provoked criticism from some officials in the US and Europe by trying to end the yearlong credit crisis through an expansion of lending. The steepest interest-rate cuts in two decades risk stoking inflation, while the Fed has been too generous in aiding banks, said Buiter, 58, a founding member of the Bank of England's independent rate-setting board in 1997.



In addition to rescuing Bear Stearns from bankruptcy, the Fed created a program to swap Treasuries for mortgage bonds, opened up lending to Wall Street firms and reduced the premium for direct loans to commercial banks.



Mishkin lashed out against Buiter's assertion that the Fed's rate reductions may cause higher consumer prices.



'Very Helpful'



''I wish he had actually read some of the literature on optimal monetary policy, because it might have been very helpful in this context,'' said Mishkin, who collaborated with Bernanke on inflation research in the 1990s.



Mishkin, a leading advocate of the Fed's effort to sustain economic growth through rapid rate reductions, said research shows that ''what you need to do is act more aggressively.''



In reply, Buiter said the value of such a strategy ''is not at all obvious to me.''



Fischer, drawing laughter from the audience, held up a red fire extinguisher saying, ''I asked the organizers for some technical assistance in dealing with this discussion.''



While defending the Fed, Blinder said Buiter's papers ''often feature an alluring mix of brilliant insight and outrageous statements.'' The central bank's performance, though not flawless, has been ''pretty good'' given the magnitude of the crisis, he said.



European Central Bank President Jean-Claude Trichet also came to the Fed's defense, saying ''what has been done until now has been pretty well done under very difficult circumstances.''



'Market Correction'



After a year of instability, ''we are still in a market correction,'' Trichet said.



The Fed, unlike the ECB and Bank of England that are charged with containing inflation, has two mandates according to law: keep consumer prices in check and maximize employment.



The world's top central-banking officials and scholars at the conference indicated the yearlong credit crisis has yet to run its course, with continued turmoil in banking and housing, Fischer said yesterday in the event's closing remarks.



Bernanke, who didn't comment at the meeting after giving the opening speech, has argued that policy makers' actions were necessary to safeguard the economy from the impact of the credit crisis.



Buiter said the Fed's emergency lending programs are too generous. The US central bank is making up to $US200 billion of its Treasuries holdings available to primary securities dealers, and $US150 billion of funds through auctions to commercial banks. In addition, banks are able to borrow directly from the Fed.



''You don't let your borrower determine the value of the collateral offered to you,'' Buiter said. ''That's just crazy.''



Too Sympathetic



Buiter also reiterated his argument that central banks can fall prey to ''regulatory capture'' by financial institutions, growing too sympathetic to their needs when setting rates.



Two economists echoed Buiter's concern in another paper presented yesterday, saying the Fed's program allowing institutions to swap Treasuries for mortgage bonds and other debt enables firms to ''window dress'' their balance sheets.



''Financial institutions can hold low-quality securities for the period where no reporting is required,'' wrote Franklin Allen of the University of Pennsylvania and the University of Frankfurt's Elena Carletti. ''Temporarily increasing the supply of Treasuries makes this kind of deception easier. It helps remove market and regulator discipline.''



The financial crisis is also forcing the ECB to rethink aspects of its money-market operations, which provide some flexibility compared with programs at the Fed and the Bank of England.



ECB Rules



The ECB plans to tighten collateral rules to head off the risk of abuse by some financial institutions, ECB council member Yves Mersch said in an interview yesterday.



Buiter nevertheless won some praise for openly confronting the Fed's record at its summer retreat in Grand Teton National Park.



''Willem's papers don't pull punches, they have attitude,'' Blinder said. ''You have to give credit to a guy with the nerve to come here with black bears on the outside and the FOMC on the inside and be this critical of the Federal Reserve.''



The FOMC refers to the central bank's rate-setting Federal Open Market Committee.

Bloomberg

