- The Washington Times - Wednesday, May 6, 2009

Federal Reserve Chairman Ben S. Bernanke said Tuesday he expects the Treasury to avoid depleting its bank bailout fund by relying on tactics other than direct cash infusions to bolster banks that fail government stress tests.

The Fed and Treasury are expected to reveal the results of the tests on 19 large banks Thursday, and reportedly will require about 10 of them to raise additional funds to ward against rising defaults and losses on loans. But the Treasury has only about $110 billion left in its $700 billion bank bailout fund to provide further support to banks as well as to shepherd Chrysler and possibly General Motors through bankruptcy.

Private estimates of the amount of new capital needed by banks range from $38 billion to $250 billion.

In an appearance before the Joint Economic Committee, Mr. Bernanke expressed optimism that banks will be able to raise much of the funds from private investors, although many Wall Street analysts warn that might be difficult in light of the rising losses at banks as well as the big losses investors experienced last year on their purchases of bank shares. It was because banks were largely shut out of private markets that they turned to the Treasury for assistance last fall.

“I do think there will be significant opportunities for capital raising outside of government sources,” Mr. Bernanke said. Most of the handful of needy banks will be able to raise funds through “either issuance of new capital or through conversions and exchanges or the sales of assets and other measures that would raise capital,” he said.

One way Treasury will be able to avoid depleting its bailout fund is to use a controversial tactic it employed with Citigroup earlier this year. That allows a bank to convert preferred shares it sold to Treasury last year into common shares, which bolsters bank balance sheets in a way that pleases investors while avoiding any new cash infusions from Treasury. But it poses some risks.

Because the preferred shares pay interest of 8 percent a year and eventually must be repaid in full to the government, to investors they look more like debt than capital. Thus the markets, which prefer unencumbered capital raised through common stock issues, have discounted the value of the original Treasury investments.

The tactic in the long run poses a greater risk that taxpayers will lose their investment. And it raises the specter of creeping nationalization as the government is likely to end up owning a majority share of stocks in the most troubled banks. The threat of such gradual nationalization caused a scare in the stock market earlier this year and prompted many bank stockholders to dump their shares.

“Obviously it’s not our intention or desire to have long-term government ownership of banks,” Mr. Bernanke said. He said the Fed’s and the Treasury’s goal is to exit the business of owning and recapitalizing banks as quickly as possible, once the financial markets and economy start to mend.

The Fed chairman repeated his hope that the economy will start to recover from the deepest recession since World War II by the end of the year. But he cautioned against expecting a sharp improvement, saying the recovery is likely to be gradual and that unemployment will remain high.

“We expect economic activity to bottom out, then to turn up later this year,” he said. “Businesses are likely to be cautious about hiring, implying that the unemployment rate could remain high for a time, even after economic growth resumes.”

Strains in the banking system and credit markets also remain significant and could derail the recovery, he said.

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