March 31 (Bloomberg) -- Federal Reserve Bank of Philadelphia President Charles Plosser said withdrawing the central bank’s emergency lending programs could provoke political pressures that threaten its independence.

“Unwinding from these lending and securities programs will not necessarily be easy,” Plosser said today in Chicago. “Interest groups” and other “pressures could threaten the Fed’s independence to control its balance sheet and monetary policy,” he said, adding the Fed “will need to have the fortitude to make some difficult decisions about when our policies must be reversed or unwound.”

The central bank has more than doubled its balance sheet to $2.1 trillion while pledging to finance a $1 trillion consumer- loan program and to buy more than $1 trillion of mortgage-debt and $300 billion of Treasuries.

Plosser and Richmond Fed Bank President Jeffrey Lacker have been among the most outspoken policy makers warning about distracting the central bank from its mission to ensure stable prices.

Plosser also backed a plan by Treasury Secretary Timothy Geithner and Fed Chairman Ben S. Bernanke, who have called for new powers to take over and wind down failing financial companies after the government’s rescue of American International Group Inc.

‘Expedited Payoffs’

“Uninsured creditors could receive expedited payoffs based on historical recoveries, generally less than 100 percent, while shareholders of the failed institution would be wiped out,” Plosser said. “This is very different from government actions taken in our current crisis, which have served to provide 100 percent protection for all creditors.”

Bernanke and Geithner also called for stronger regulation to contain the risks taken by firms that may endanger the financial system.

Plosser said it would be “wrong-headed” to create new regulations to reduce the probability of failure.

“Such an approach would generate large supervisory costs, stifle innovation and result in regulatory arbitrage,” he said to students at the University of Chicago Booth School of Business. “The objective should be to reduce the systemic costs of failures.”

While the Federal Deposit Insurance Corp. has the power to take over failing deposit-taking firms and wind down their assets, no such authority exists for financial firms that aren’t classified as banks. Such institutions include American International Group Inc. and hedge funds with extensive links throughout the banking system.

Avert Inflation

In order to avert inflation, the Fed may need to begin curtailing emergency credit before job losses begin to subside, Plosser said.

“The economy is going to turn around long before unemployment rates peak,” Plosser told reporters after the speech.

“It may be that the Fed may have to start withdrawing from some of these programs before many people believe the economy is completely healed,” he said. “Simply because once that process starts we’ve got to get out in front of it, otherwise we may be faced with lots of inflation down the road.”

The U.S. needs regulations that compel supervisors to act in a “predictable way” rather than with ad hoc measures, Plosser said in response to an audience question. “Make the hurdles higher to make it more difficult” for regulators to depart from planned approaches in oversight, he said.

Hedge Funds

Plosser also said he saw no reason to increase regulation of hedge funds.

“I am not a big fan of regulating hedge funds per se,” he said. During the financial crisis, “hedge funds haven’t distinguished themselves, but they have done a lot better than a lot of institutions.”

Banks and financial institutions worldwide have reported more than $1.2 trillion in credit losses and writedowns. Many of those losses stemmed from mortgage-related investments that declined with the collapse in the housing market.

Plosser is a former professor and business-school dean at the University of Rochester who took the helm of the Philadelphia Fed bank in August 2006.

To contact the reporters on this story: Steve Matthews in Atlanta at smatthews@bloomberg.net; Whitney McFerron in Chicago at wmcferron1@bloomberg.net.

Last Updated: March 31, 2009 15:23 EDT