Bernanke's Testimony to Senate Banking Community: Full Text
2008-09-23 11:42:03.310 GMT
Sept. 23 (Bloomberg) -- The following is a reformatted
version of the text of Federal Reserve Chairman Ben S. Bernanke's
statement to the Senate Banking Committee.
Chairman Dodd, Senator Shelby, and members of the Committee,
I appreciate this opportunity to discuss recent developments in
financial markets and the economy. As you know, the U.S. economy
continues to confront substantial challenges, including a
weakening labor market and elevated inflation. Notably, stresses
in financial markets have been high and have recently intensified
significantly. If financial conditions fail to improve for a
protracted period, the implications for the broader economy could
be quite adverse.
The downturn in the housing market has been a key factor
underlying both the strained condition of financial markets and
the slowdown of the broader economy. In the financial sphere,
falling home prices and rising mortgage delinquencies have led to
major losses at many financial institutions, losses only
partially replaced by the raising of new capital. Investor
concerns about financial institutions increased over the summer,
as mortgage-related assets deteriorated further and economic
activity weakened. Among the firms under the greatest pressure
were Fannie Mae and Freddie Mac, Lehman Brothers, and, more
recently, American International Group (AIG). As investors lost
confidence in them, these companies saw their access to liquidity
and capital markets increasingly impaired and their stock prices
drop sharply.
The Federal Reserve believes that, whenever possible, such
difficulties should be addressed through private-sector
arrangements--for example, by raising new equity capital, by
negotiations leading to a merger or acquisition, or by an orderly
wind-down. Government assistance should be given with the
greatest of reluctance and only when the stability of the
financial system, and, consequently, the health of the broader
economy, is at risk. In the cases of Fannie Mae and Freddie Mac,
however, capital raises of sufficient size appeared infeasible
and the size and government-sponsored status of the two companies
precluded a merger with or acquisition by another company. To
avoid unacceptably large dislocations in the financial sector,
the housing market, and the economy as a whole, the Federal
Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac
into conservatorship, and the Treasury used its authority,
granted by the Congress in July, to make available financial
support to the two firms. The Federal Reserve, with which FHFA
consulted on the conservatorship decision as specified in the
July legislation, supported these steps as necessary and
appropriate. We have seen benefits of this action in the form of
lower mortgage rates, which should help the housing market.
The Federal Reserve and the Treasury attempted to identify
private-sector approaches to avoid the imminent failures of AIG
and Lehman Brothers, but none was forthcoming. In the case of
AIG, the Federal Reserve, with the support of the Treasury,
provided an emergency credit line to facilitate an orderly
resolution. The Federal Reserve took this action because it
judged that, in light of the prevailing market conditions and the
size and composition of AIG's obligations, a disorderly failure
of AIG would have severely threatened global financial stability
and, consequently, the performance of the U.S. economy. To
mitigate concerns that this action would exacerbate moral hazard
and encourage inappropriate risk-taking in the future, the
Federal Reserve ensured that the terms of the credit extended to
AIG imposed significant costs and constraints on the firm's
owners, managers, and creditors. The chief executive officer has
been replaced. The collateral for the loan is the company
itself, together with its subsidiaries. (Insurance
policyholders and holders of AIG investment products are,
however, fully protected.) Interest will accrue on the
outstanding balance of the loan at a rate of three-month Libor
plus 850 basis points, implying a current interest rate over 11
percent. In addition, the U.S. government will receive equity
participation rights corresponding to a 79.9 percent equity
interest in AIG and has the right to veto the payment of
dividends to common and preferred shareholders, among other
things.
In the case of Lehman Brothers, a major investment bank, the
Federal Reserve and the Treasury declined to commit public funds
to support the institution. The failure of Lehman posed risks.
But the troubles at Lehman had been well known for some time, and
investors clearly recognized--as evidenced, for example, by the
high cost of insuring Lehman's debt in the market for credit
default swaps--that the failure of the firm was a significant
possibility. Thus, we judged that investors and counterparties
had had time to take precautionary measures.
While perhaps manageable in itself, Lehman's default was combined
with the unexpectedly rapid collapse of AIG, which together
contributed to the development last week of extraordinarily
turbulent conditions in global financial markets. These
conditions caused equity prices to fall sharply, the cost of
short-term credit--where available--to spike upward, and
liquidity to dry up in many markets. Losses at a large money
market mutual fund sparked extensive withdrawals from a number of
such funds. A marked increase in the demand for safe assets--a
flight to quality--sent the yield on Treasury bills down to a few
hundredths of a percent. By further reducing asset values and
potentially restricting the flow of credit to households and
businesses, these developments pose a direct threat to economic
growth.
The Federal Reserve took a number of actions to increase
liquidity and stabilize markets. Notably, to address dollar
funding pressures worldwide, we announced a significant expansion
of reciprocal currency arrangements with foreign central banks,
including an approximate doubling of the existing swap lines with
the European Central Bank and the Swiss National Bank and the
authorization of new swap facilities with the Bank of Japan, the
Bank of England, and the Bank of Canada. We will continue to
work closely with colleagues at other central banks to address
ongoing liquidity pressures. The Federal Reserve also announced
initiatives to assist money market mutual funds facing heavy
redemptions and to increase liquidity in short-term credit
markets.
Despite the efforts of the Federal Reserve, the Treasury,
and other agencies, global financial markets remain under
extraordinary stress. Action by the Congress is urgently
required to stabilize the situation and avert what otherwise
could be very serious consequences for our financial markets and
for our economy. In this regard, the Federal Reserve supports
the Treasury's proposal to buy illiquid assets from financial
institutions. Purchasing impaired assets will create liquidity
and promote price discovery in the markets for these assets,
while reducing investor uncertainty about the current value and
prospects of financial institutions. More generally, removing
these assets from institutions' balance sheets will help to
restore confidence in our financial markets and enable banks and
other institutions to raise capital and to expand credit to
support economic growth.
At this juncture, in light of the fast-moving developments
in financial markets, it is essential to deal with the crisis at
hand. Certainly, the shortcomings and weaknesses of our
financial markets and regulatory system must be addressed if we
are to avoid a repetition of what has transpired in our financial
markets over the past year. However, the development of a
comprehensive proposal for reform would require careful and
extensive analysis that would be difficult to compress into a
short legislative timeframe now available. Looking forward, the
Federal Reserve is committed to working closely with the
Congress, the Administration, other federal regulators, and other
stakeholders in developing a stronger, more resilient, and better
regulated financial system.
2008-09-23 11:42:03.310 GMT
Sept. 23 (Bloomberg) -- The following is a reformatted
version of the text of Federal Reserve Chairman Ben S. Bernanke's
statement to the Senate Banking Committee.
Chairman Dodd, Senator Shelby, and members of the Committee,
I appreciate this opportunity to discuss recent developments in
financial markets and the economy. As you know, the U.S. economy
continues to confront substantial challenges, including a
weakening labor market and elevated inflation. Notably, stresses
in financial markets have been high and have recently intensified
significantly. If financial conditions fail to improve for a
protracted period, the implications for the broader economy could
be quite adverse.
The downturn in the housing market has been a key factor
underlying both the strained condition of financial markets and
the slowdown of the broader economy. In the financial sphere,
falling home prices and rising mortgage delinquencies have led to
major losses at many financial institutions, losses only
partially replaced by the raising of new capital. Investor
concerns about financial institutions increased over the summer,
as mortgage-related assets deteriorated further and economic
activity weakened. Among the firms under the greatest pressure
were Fannie Mae and Freddie Mac, Lehman Brothers, and, more
recently, American International Group (AIG). As investors lost
confidence in them, these companies saw their access to liquidity
and capital markets increasingly impaired and their stock prices
drop sharply.
The Federal Reserve believes that, whenever possible, such
difficulties should be addressed through private-sector
arrangements--for example, by raising new equity capital, by
negotiations leading to a merger or acquisition, or by an orderly
wind-down. Government assistance should be given with the
greatest of reluctance and only when the stability of the
financial system, and, consequently, the health of the broader
economy, is at risk. In the cases of Fannie Mae and Freddie Mac,
however, capital raises of sufficient size appeared infeasible
and the size and government-sponsored status of the two companies
precluded a merger with or acquisition by another company. To
avoid unacceptably large dislocations in the financial sector,
the housing market, and the economy as a whole, the Federal
Housing Finance Agency (FHFA) placed Fannie Mae and Freddie Mac
into conservatorship, and the Treasury used its authority,
granted by the Congress in July, to make available financial
support to the two firms. The Federal Reserve, with which FHFA
consulted on the conservatorship decision as specified in the
July legislation, supported these steps as necessary and
appropriate. We have seen benefits of this action in the form of
lower mortgage rates, which should help the housing market.
The Federal Reserve and the Treasury attempted to identify
private-sector approaches to avoid the imminent failures of AIG
and Lehman Brothers, but none was forthcoming. In the case of
AIG, the Federal Reserve, with the support of the Treasury,
provided an emergency credit line to facilitate an orderly
resolution. The Federal Reserve took this action because it
judged that, in light of the prevailing market conditions and the
size and composition of AIG's obligations, a disorderly failure
of AIG would have severely threatened global financial stability
and, consequently, the performance of the U.S. economy. To
mitigate concerns that this action would exacerbate moral hazard
and encourage inappropriate risk-taking in the future, the
Federal Reserve ensured that the terms of the credit extended to
AIG imposed significant costs and constraints on the firm's
owners, managers, and creditors. The chief executive officer has
been replaced. The collateral for the loan is the company
itself, together with its subsidiaries. (Insurance
policyholders and holders of AIG investment products are,
however, fully protected.) Interest will accrue on the
outstanding balance of the loan at a rate of three-month Libor
plus 850 basis points, implying a current interest rate over 11
percent. In addition, the U.S. government will receive equity
participation rights corresponding to a 79.9 percent equity
interest in AIG and has the right to veto the payment of
dividends to common and preferred shareholders, among other
things.
In the case of Lehman Brothers, a major investment bank, the
Federal Reserve and the Treasury declined to commit public funds
to support the institution. The failure of Lehman posed risks.
But the troubles at Lehman had been well known for some time, and
investors clearly recognized--as evidenced, for example, by the
high cost of insuring Lehman's debt in the market for credit
default swaps--that the failure of the firm was a significant
possibility. Thus, we judged that investors and counterparties
had had time to take precautionary measures.
While perhaps manageable in itself, Lehman's default was combined
with the unexpectedly rapid collapse of AIG, which together
contributed to the development last week of extraordinarily
turbulent conditions in global financial markets. These
conditions caused equity prices to fall sharply, the cost of
short-term credit--where available--to spike upward, and
liquidity to dry up in many markets. Losses at a large money
market mutual fund sparked extensive withdrawals from a number of
such funds. A marked increase in the demand for safe assets--a
flight to quality--sent the yield on Treasury bills down to a few
hundredths of a percent. By further reducing asset values and
potentially restricting the flow of credit to households and
businesses, these developments pose a direct threat to economic
growth.
The Federal Reserve took a number of actions to increase
liquidity and stabilize markets. Notably, to address dollar
funding pressures worldwide, we announced a significant expansion
of reciprocal currency arrangements with foreign central banks,
including an approximate doubling of the existing swap lines with
the European Central Bank and the Swiss National Bank and the
authorization of new swap facilities with the Bank of Japan, the
Bank of England, and the Bank of Canada. We will continue to
work closely with colleagues at other central banks to address
ongoing liquidity pressures. The Federal Reserve also announced
initiatives to assist money market mutual funds facing heavy
redemptions and to increase liquidity in short-term credit
markets.
Despite the efforts of the Federal Reserve, the Treasury,
and other agencies, global financial markets remain under
extraordinary stress. Action by the Congress is urgently
required to stabilize the situation and avert what otherwise
could be very serious consequences for our financial markets and
for our economy. In this regard, the Federal Reserve supports
the Treasury's proposal to buy illiquid assets from financial
institutions. Purchasing impaired assets will create liquidity
and promote price discovery in the markets for these assets,
while reducing investor uncertainty about the current value and
prospects of financial institutions. More generally, removing
these assets from institutions' balance sheets will help to
restore confidence in our financial markets and enable banks and
other institutions to raise capital and to expand credit to
support economic growth.
At this juncture, in light of the fast-moving developments
in financial markets, it is essential to deal with the crisis at
hand. Certainly, the shortcomings and weaknesses of our
financial markets and regulatory system must be addressed if we
are to avoid a repetition of what has transpired in our financial
markets over the past year. However, the development of a
comprehensive proposal for reform would require careful and
extensive analysis that would be difficult to compress into a
short legislative timeframe now available. Looking forward, the
Federal Reserve is committed to working closely with the
Congress, the Administration, other federal regulators, and other
stakeholders in developing a stronger, more resilient, and better
regulated financial system.
