Washington: Turmoil in financial markets has eased somewhat, but the situation is still “far from normal,” Federal Reserve Chairman Ben Bernanke said Tuesday.
The central bank has taken a number of unconventional steps _ especially since March, when the credit crisis intensified _ to help squeezed banks and big investment firms overcome problems and try to get credit flowing more freely again.
Those efforts appear to be paying off and “have contributed to some improvement in financing markets,” the Fed chief said in prepared remarks delivered via satellite to a financial markets conference sponsored by the Federal Reserve Bank of Atlanta in Sea Island, Georgia.
Bernanke noted some improvements in the markets for certain mortgage-backed securities, such as those backed by Fannie Mae and Freddie Mac, as well as some fixed-rate mortgages and corporate debt.
Moreover, the Fed’s extraordinary decision in March to let investment firms go to the Fed for emergency loans “seems to have bolstered confidence,” Bernanke said.
“These are welcome signs, of course, but at this stage conditions in financial markets are still far from normal,” he said.
For instance, there are still strains involving a widely used interest rate called the London interbank offered rate, or Libor, Bernanke said. And “funding pressures” have also been evident in the “strong participation” of commercial banks in a Fed auction program that has made billions of dollars available in short-term cash loans, he said.
Bernanke said the Fed policymakers “stand ready” to further increase the size of these loans in the future if warranted by financial developments.
In his speech, Bernanke did not talk about the Fed’s next move on interest rates or the broader state of the U.S. economy, which many fear is on the edge of a recession or in one already.
To bolster the economy, the Fed last month cut a key interest rate by one-quarter percentage point to 2%. At the same time, policymakers indicated that their rate-cutting campaign, which started in September, could be drawing to a close. If that happens, many economists believe the Fed will focus more on its various efforts to relieve stressed credit markets.
After a run on Bear Stearns pushed the U.S.’s fifth-largest investment bank to the brink of bankruptcy in March, fears grew that others might be in jeopardy, given major stresses in credit and financial markets at that time.
Scrambling to avert a market meltdown, the Fed _ in the broadest use of the central bank’s lending authority since the 1930s _ agreed in March to temporarily let investment firms obtain emergency financing from the Fed, a privilege previously granted only to commercial banks. That’s one of the Fed’s most significant actions.
The Fed also has moved to make cash loans to commercial banks and to make super-safe Treasury securities available to investment firms. All these efforts are aimed at bolstering confidence and getting firms to behave in a more normal fashion so they’ll be more inclined to lend to each other, consumers and businesses.
Ultimately, financial companies will need to raise new capital and improve risk management to address the fundamental sources of financial strains, Bernanke said. “This process is likely to take some time,” he added.
And once financial conditions become more normal, the extraordinary provisions to provide ready sources of cash to financial institutions will no longer be needed, he said.
Even as the Fed has stepped in to provide such help, it also is mindful of creating a “moral hazard,” where financial institutions might be more inclined to take certain risks if they believe the Fed will be there to bail them out.
“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,” Bernanke said.
The Fed is reviewing its policies on this front to see if improvements can be made, he said.
“Of course, even the most carefully crafted regulations cannot ensure that liquidity crises will not happen again,” Bernanke said. But if moral hazard is mitigated and if financial institutions and investors tighten up risk-management practices, “the frequency and the severity of future crises should be significantly reduced,” he said.