Bernanke Says Markets Healing but Still Not Well

By Reuters -  |  Posted 2008-05-13 Print this article Print

The Federal Reserve Chairman speaks about the current market conditions.

SEA ISLAND, Georgia (Reuters) - U.S. Federal Reserve Chairman Ben Bernanke said on Tuesday that emergency Fed liquidity measures have helped relieve strain in financial markets, but the recovery process remains incomplete.

"To date, our liquidity measures appear to have contributed to some improvement in financing markets," he said in remarks prepared for delivery to the Federal Reserve Bank of Atlanta's annual conference.

"These are welcome signs, of course, but at this stage conditions in financial markets are still far from normal. A number of securitization markets remain moribund," he said in remarks to be transmitted via video link from Washington.

Bernanke noted a "substantial" improvement in the market for Treasury repurchase agreements and narrower spreads on agency mortgage backed securities and corporate debt. But he said risk spreads remained generally high, while strong demand for liquidity from the Fed showed funding problems persist.

"Ultimately, market participants themselves must address the fundamental sources of financial strains -- through deleveraging, raising new capital, and improving risk management -- and this process is likely to take some time."

"The Federal Reserve's various liquidity measures should help facilitate that process indirectly by boosting investor confidence and by reducing the risks of severe disruption during the period of adjustment," Bernanke said.

Bernanke said the size of auctions of liquid funds for banks under the Term Auction Facility created in December, which already have been increased to $75 billion from $20 billion, could be upped again if demanded by market conditions.

The Fed has slashed interest rates by 3.25 percentage points since mid-September and pumped billions of dollars into financial markets to stop them seizing up amid a global credit crunch sparked by the U.S. subprime mortgage crisis.

Controversially, the Fed's steps also included a massive cash line that enabled JPMorgan to rescue faltering investment bank Bear Stearns. Defending the Fed's actions, Bernanke said a Bear Stearns bankruptcy could have touched off a much broader liquidity crisis.

Bernanke acknowledged intervention risked a moral hazard that investors would renew risky behavior in the expectation of being protected by the central bank. But he said regulation ahead of a crisis was the best way to address that risk.

"The problem of moral hazard can perhaps be most effectively addressed by prudential supervision and regulation that ensures that financial institutions manage their liquidity risks effectively in advance of the crisis," he said.

"In particular, future liquidity planning will have to take into account the possibility of a sudden loss of substantial amounts of secured financing," he said, noting that bank supervisors aimed to ensure that institutions had adequate risk-management measures in place.

Bernanke said the creation of the Term Auction Facility appeared to have overcome "to a significant degree" the stigma of borrowing directly from the Fed at its traditional discount window. Banks are often hesitant to borrow at the window out of worry their borrowing will become known by market participants, who might view them as being in financial distress.

He also said measures to provide liquidity to large Wall Street dealers had been helpful, saying that they appeared to have bolstered confidence among dealers' counterparties.

(Reporting by Alister Bull, Editing by Andrea Ricci)


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