Bernanke Says Markets Healing but Still Not Well

SEA ISLAND,Georgia (Reuters) – U.S. Federal Reserve Chairman Ben Bernanke said onTuesday that emergency Fed liquidity measures have helped relievestrain in financial markets, but the recovery process remainsincomplete.

"To date, our liquidity measures appear to have contributed to someimprovement in financing markets," he said in remarks prepared fordelivery to the Federal Reserve Bank of Atlanta’s annual conference.

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

Bernanke noted a "substantial" improvement in the market forTreasury repurchase agreements and narrower spreads on agency mortgagebacked securities and corporate debt. But he said risk spreads remainedgenerally high, while strong demand for liquidity from the Fed showedfunding problems persist.

"Ultimately, market participants themselves must address thefundamental sources of financial strains — through deleveraging,raising new capital, and improving risk management — and this processis likely to take some time."

"The Federal Reserve’s various liquidity measures should helpfacilitate that process indirectly by boosting investor confidence andby reducing the risks of severe disruption during the period ofadjustment," Bernanke said.

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

The Fed has slashed interest rates by 3.25 percentage points sincemid-September and pumped billions of dollars into financial markets tostop 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 linethat enabled JPMorgan to rescue faltering investment bank Bear Stearns.Defending the Fed’s actions, Bernanke said a Bear Stearns bankruptcycould have touched off a much broader liquidity crisis.

Bernanke acknowledged intervention risked a moral hazard thatinvestors would renew risky behavior in the expectation of beingprotected by the central bank. But he said regulation ahead of a crisiswas the best way to address that risk.

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

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

Bernanke said the creation of the Term Auction Facility appeared tohave overcome "to a significant degree" the stigma of borrowingdirectly from the Fed at its traditional discount window. Banks areoften hesitant to borrow at the window out of worry their borrowingwill become known by market participants, who might view them as beingin financial distress.

He also said measures to provide liquidity to large Wall Streetdealers had been helpful, saying that they appeared to have bolsteredconfidence among dealers’ counterparties.

(Reporting by Alister Bull, Editing by Andrea Ricci)