Fed wants focus on banks

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By Patrice Hill

Federal Reserve Chairman Ben S. Bernanke said Tuesday that increasingly unpopular rescues of banks should remain the focus of the Treasury's $700 billion bailout program because banks are still fragile and weighed down by souring loans.

In a speech only a day after President-elect Barack Obama highlighted how he would use the program to help consumers, delinquent homeowners, small businesses and even stressed state and local governments, Mr. Bernanke acknowledged that bailing out banks has become unpopular in Congress, but he said that nurturing the financial system back to health must remain the Treasury's top priority.

To emphasize his point, the Fed chief said that while he welcomes Mr. Obama's $800 billion stimulus program, it would not succeed in reviving the economy unless accompanied by continued vigorous efforts to resuscitate ailing banks and financial markets.

"Fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system," he told the London School of Economics. "History demonstrates conclusively that a modern economy cannot grow if its financial system is not operating effectively."

More major banks may need to get government support, including further cash injections from the Treasury as well as some sharing of losses on delinquent loans by taxpayers, he said.

The Treasury's rescue of Citigroup before Thanksgiving posed one model for further assisting banks with bad-loan problems, he said, although other ways could be found to help them survive the growing problems with loans in real estate, credit cards and businesses.

A little-known aspect of the bailout program is the support it has given to the Fed's efforts to revive moribund financial markets, including the commercial paper market used by businesses to float short-term debt, which Mr. Bernanke said is now showing signs of life as a result. The Treasury provided a small amount of seed funding for that program, as it has for a new program the Fed will launch this month to try to revive the collapsed market for securities backed by credit card debt, student loans, auto loans and small-business loans.

Banks curtailed loans to students, car buyers and other consumers after the markets for securitized loans collapsed, so the Fed programs are aimed at helping revive credit for strapped businesses and consumers that legislators say they want to benefit.

Given how unpopular the bank bailouts have become, Mr. Bernanke said lawmakers will have to carefully communicate to the public why it is essential to keep the banking system and financial system alive.

"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. Our economic system is critically dependent on the free flow of credit, and the consequences for the broader economy of financial instability are thus powerful and quickly felt. Indeed, the destructive effects of financial instability on jobs and growth are already evident worldwide."

In requesting the second $350 billion installment for the bailout program, Mr. Obama and his aides have been careful to say that they, too, need Congress to authorize the funding so they can address financial emergencies, which will continue to take priority under the program.

But they also have sought to quell opposition in Congress by highlighting their plans to use the money to stop preventable foreclosures as well as help strapped small businesses and municipal governments that are suffering from the recession. Much of the opposition in Congress has centered on the Treasury's failure under Secretary Henry M. Paulson Jr. to set up a program to help homeowners facing foreclosure.

Mr. Obama assured Senate Democrats in an hour-long meeting Tuesday that he would improve spending of the bailout funds and impose strict oversight of the banks and companies that receive assistance.

Sen. Joe Lieberman, an independent from Connecticut who caucuses with Democrats, said he found Mr. Obama "very convincing" in his appeal for the funds, and predicted the final vote would show "overwhelming support" for the president-elect.

Still, Sen. Ben Nelson, Nebraska Democrat, said he was not sure whether he would vote to support releasing the rest of the funds, calling the bailout "poisoned" in the eyes of the American public.

"It may be more than a blank check, but it's a big check," he said. "It's a public relations nightmare and I don't know what to tell people back home about how it's being spent."

Mr. Obama has focused his effort on the Senate, where leaders hope to vote on the bailout funding by Sunday. He appears to have a better chance there than in the House, where Democratic leaders are more hostile to releasing the funds and keen to reopen the debate about how the money is spent.

Senate Republicans want Mr. Obama to spend more of the money to clear toxic loan assets, as the program was originally designed to do.

Senate Minority Leader Mitch McConnell, Kentucky Republican, said the Bush administration's decision to spend the first $350 billion buying equity stakes in Wall Street houses and to bail out U.S. automakers had sapped Republican enthusiasm for the program.

• Christina Bellantoni, S.A. Miller, Sean Lengell and David R. Sands contributed to this report.