- The Washington Times - Tuesday, January 13, 2009

UPDATED:

Federal Reserve Chairman Ben S. Bernanke said Tuesday that President-elect Barack Obama’s proposed $800 billion plan to help end the recession could be “a significant boost to economic activity” but served notice it may not go far enough unless “strong measures” are taken to stabilize the financial system.

He also warned in a speech to the London School of Economics that much more regulatory supervision is necessary “to limit the probability and severity of future crises” in the financial sector.

“Particularly pressing,” he said, “is the need to address the problem of financial institutions that are deemed too big to fail.’ It is unacceptable that large firms that the government is now compelled to support to preserve financial stability were among the greatest risk-takers during the boom period.”

Mr. Bernanke mentioned no names, but one of those companies is American International Group, the giant New York-based insurance firm that received at least $125 billion in federal bailout money.

“In the future,” he said, emphasizing the need for tough regulation generally, “financial firms of any type whose failure would pose a systemic risk must accept especially close regulatory scrutiny of their risk-taking.”

It marked the first time that the Fed chief publicly addressed Mr. Obama’s proposed $800 billion economic stimulus plan, which Congress is debating. The president-elect, who takes office Jan. 20, has put together a package that includes $300 billion in tax cuts and spending proposals to repair the nation’s infrastructure.

Mr. Bernanke said it will not be enough unless financial institutions are made sound.

“The incoming administration and the Congress are currently discussing a substantial fiscal package that, if enacted, could provide a significant boost to economic activity,” he said.

“In my view, however, fiscal actions are unlikely to promote lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system,” said Mr. Bernanke, an acknowledged expert on the Great Depression.

“History demonstrates conclusively that a modern economy cannot grow if its financial system is not operating effectively,” he said.

The Treasury Department has spent about $350 billion of a $700 billion bailout package that is intended to help financial institutions, $250 billion of which has been earmarked for banks in return for part government ownership.

Further, Mr. Bernanke said, the Federal Deposit Insurance Corp. has expanded guarantees for bank liabilities and various liquidity programs sponsored by the Fed.

But, he said, “more capital injections and guarantees may become necessary to ensure stability and the normalization of credit markets.”

A “barrier to private investment in financial institutions,” the Fed chief warned, is the “large quantity” of assets on the balance sheets of those institutions that are difficult to value.

“The presence of these assets significantly increases uncertainty about the underlying value of these institutions and may inhibit both new private investment and new lending,” he warned.

Mr. Bernanke mentioned no names, but New York-based Citigroup, the third-largest U.S. bank, could report fourth quarter losses of more than $10 billion Jan. 22. It received a $20 billion bailout from the Treasury’s Troubled Asset Relief Program, or TARP, in November after having received $25 billion earlier.

Mr. Bernanke outlined three approaches the Fed might take to remove troubled assets from the balance sheets of financial institutions. They are:

• Public purchases of troubled assets.

• Government absorption of part of the prospective losses on specified portfolios of troubled assets held by banks, presumably in return for some form of compensation.

• “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.”

“In addition,” Mr. Bernanke said, “efforts to reduce preventable foreclosures … could strengthen the housing market and reduce mortgage losses, thereby increasing financial stability.”

The Fed chief seemed to emphasize the need to institute regulatory measures to ensure avoidance of future financial collapses. He said “regulatory oversight should be coordinated internationally” because of the multinational character of the largest financial firms and the globalization of financial markets.

“We need stronger supervisory and regulatory systems under which gaps and unnecessary duplication in coverage are eliminated, lines of supervisory authority and responsibility are clarified and oversight powers are adequate to curb excessive leverage and risk-taking,” Mr. Bernanke said.

He gave a sympathetic nod to public concern worldwide about how governments are helping troubled financial institutions but are letting other industries sink.

“This disparate treatment, unappealing as it is, appears unavoidable,” Mr. Bernanke said. “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.”

To help people understand why governments first must help financial institutions, he said, “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.”

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