Bernanke: No ‘lasting’ recovery without more bank aid
There will be no “lasting” recovery without more government action and additional money to strengthen the financial system, Federal Reserve Chairman Ben Bernanke said Tuesday.
The timing and strength of economic recovery “are highly uncertain,” Bernanke told an audience in London.
In what’s likely to be a sobering message to Congress, Bernanke did not say the end was near. He said that the stimulus package championed by President-elect Barack Obama would likely help the economy but wouldn’t be enough on its own.
“In my view … fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system,” Bernanke said.
The next step is to get toxic assets off bank balance sheets, he said. He outlined several ways to do this, including setting up “bad banks” to hold the troubled assets, mostly mortgage debt.
As yet, the financial crisis has no end in sight, given the weak economy, Bernanke said.
Banks have stopped lending out of a fear that they won’t be repaid. Investors have essentially shunned all financial assets worried that they will lose all their money.
The weak U.S. economy isn’t helping matters either, with analysts hoping the situation is now at its worst stretch. Growth cratered in the fourth quarter — estimates now center at an annual drop of 5% or more, which would be the sharpest such decline in 26 years.
And this quarter isn’t shaping up to be much better, as the Big Three U.S. auto companies have halted production. Lack of credit is strangling businesses and consumers are reeling from a combination of high gas prices and the housing-market recession.
“With the worsening of the economy’s growth prospects, continued credit losses and asset markdowns may maintain for a time the pressure on the capital and balance-sheet capacities of financial institutions,” he said in a speech to the London School of Economics.
As a result, the first order of business must be further stabilizing the financial system, he said.
Financial markets remain frozen partly because a “large quantity of troubled, hard-to-value assets” is still on institutions’ balance sheets, Bernanke said.
There are several ways to solve this problem, he said, all involving public funds.
The government could simply buy the troubled assets, or it could give asset guarantees and agree to absorb part of the prospective losses, he said.
“Yet another approach would be to set up and capitalize so-called ‘bad banks,’ which would purchase assets from financial institutions in exchange for cash and equity in the bad bank,” Bernanke said.
Treasury Secretary Henry Paulson initially requested the $700 billion contained in the government’s Troubled Asset Relief Program to purchase toxic assets, but he changed course after he sensed that banks were in dire need of capital. Setting up the cumbersome plan to reverse-auction assets would take too long, he said.
But the problem of these assets has continued to fester.
Monday, Obama moved to get the remaining $350 billion bailout funds from Congress.
Bernanke’s suggestions would presumably end up costing more than this.
Many experts have suggested that the price-tag for the financial market rescue is going to jump higher. Former Fed Chairman Alan Greenspan, for instance, discussed the possibility in a recent essay in the Economist magazine. But it remains unclear how this message will be received by Congress.
The initial rescue package raised deep controversy due to its size and the limited number of conditions attached to the assistance, and unease over the measures quickly made its way to lawmakers.
Still room for policy moves
Bernanke said the Fed still has weapons to fight the financial crisis, even though its federal funds target rate — currently set at a range of 0% -0.25% — cannot be reduced “meaningfully further.”
He said that he expects inflation to moderate further and that the Fed would make sure that its “exit strategy” from the unconventional easing would be accomplished in a smooth manner.
Since the crisis began, the Federal Reserve has slashed interest rates to record-low levels and has expanded its balance sheet by more than $1 trillion to ease the financial crisis.
It has also started an alphabet soup of programs that are essentially stepping in to prop up private markets.
Bernanke said again that the Fed is considering purchasing longer-term Treasury securities.
As the central bank enters such uncharted territory, Bernanke’s speech could be seen as an attempt to address some of the most prominent concerns, including concern that the new policy could turn out to be the Fed’s “Vietnam” — meaning it has no exit strategy.
Some Fed watchers are also concerned about how financial markets might react when the Fed unwinds its operations.
Bernanke promised that the Fed “will take all necessary actions to ensure that the unwinding of our programs is accomplished smoothly and in a timely way.”
Other analysts have worried that the Fed is taking too many long-term securities onto its balance sheet, some of which may be hard to sell. Bernanke said the central bank is watching this and does “not expect a significant problem in reducing our balance sheet to the extent necessary at the appropriate time.”
Some observers have worried that the Fed is effectively printing money which will ultimately be inflationary, to which Bernanke responded that the Fed sees “little risk of inflation in the near term. Indeed, we expect inflation to continue to moderate.”
Congress’ turn to explain
But much of his talk seemed aimed at members of Congress. He urged them to help explain to taxpayers why they must assist in restoring financial markets to health.
“The public in many countries is understandably concerned by the commitment of substantial government resources to aid the financial industry when other industries receive little or no assistance,” he said.
“This disparate treatment, unappealing as it is, appears unavoidable,” he said.
Bernanke again said that without the free flow of credit, there would be an immediate downturn in economic activity.
“Responsible policymakers must therefore do what they can to communicate to their constituencies why financial stabilization is essential for economic recovery and is therefore in the broader public interest,” he said.
Asked about the prospects for the U.S. economy, Bernanke repeated his forecast that there may be some stabilization this year.
“We are currently in a very bad stage of the contraction as far as employment is concerned, and I would expect to see continued weakness in the first quarter,” he said.
“As we look forward, there is a lot of uncertainty, but I am hopeful that later in 2009 — depending on factors, particularly including the financial and credit markets — we should begin to see some stabilization in the economy … a stop to the bleeding, in a sense.”