Bernanke says Fed to boost loans to banks as needed

Wednesday, May 14, 2008 at 1:38am

Federal Reserve Chairman Ben S. Bernanke said Tuesday that financial markets remain unsettled and the central bank will increase its auctions of cash to banks as needed.

While markets have improved, they remain “far from normal,” Bernanke said yesterday in a speech to an Atlanta Fed conference at Sea Island, Ga. “We stand ready to increase the size of the auctions if further warranted by financial developments.”

Bernanke’s comments contrast with those by Treasury Secretary Henry Paulson and Wall Street leaders including Vikram Pandit, chief executive officer of Citigroup Inc., who say the worst of the credit crisis is over.

The Fed chief said it will take “some time” for financial firms to resolve the crisis by raising new capital and strengthening their management of risk.

The flight from risk since August has made financial institutions reluctant to lend to each other, driving up banks’ borrowing costs. The central bank has made its own balance sheet available to both banks and bond dealers through three new lending tools and an expansion of existing programs.

Bernanke said the Fed’s efforts have yielded “some improvement,” while also noting that the steps raise questions regarding moral hazard, or protecting those who take on risk.

The central bank’s extension of the federal safety net also opened a debate about whether the government should now use taxpayer money to stem mortgage foreclosures, the primary cause of market distress.

The U.S. House of Representatives last week approved a Democratic foreclosure-prevention package over Republican objections and a White House veto threat. The legislation would create a program at the Federal Housing Administration to insure up to $300 billion in refinanced mortgages after loan holders agree to cut principal to make payments affordable.

“A central bank that is too quick to act as a liquidity provider of last resort risks inducing moral hazard,” Bernanke said. The belief that the Fed is always standing by would give “financial institutions and their creditors less incentive to pursue suitable strategies for managing liquidity risk and more incentive to take such risks.”

Bernanke didn't discuss the path of interest rates or the outlook for the economy.

The Fed chairman said federal banking agencies are trying to address moral hazard through a review of “policies and guidance regarding liquidity risk management to determine what improvements can be made.”

“Future liquidity planning will have to take into account the possibility of a sudden loss of substantial amounts of secured financing,” Bernanke said. “Ultimately, market participants themselves must address the fundamental sources of financial strains — through de-leveraging, raising new capital and improving risk management.”

That process will take time, he added, noting that “once financial conditions become more normal, the extraordinary provision by the Federal Reserve will no longer be needed.”

— Bloomberg News

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