Ben S Bernanke: Troubled Asset Relief Program and the Federal
Reserve's liquidity facilities
Testimony of Mr Ben S Bernanke, Chairman of the Board of Governors of the US Federal
Reserve System, before the Committee on Financial Services, US House of
Representatives, Washington DC, 18 November 2008.
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Chairman Frank, Ranking Member Bachus, and other members of the Committee, I
appreciate having this opportunity to review some of the activities to date of the Treasury's
Troubled Asset Relief Program, or TARP, and to discuss recent steps taken by the Federal
Reserve and other agencies to support the normalization of credit markets.
The legislation that created the TARP put in place a Financial Stability Oversight Board to
review the actions of the Treasury in administering the program. That Oversight Board
includes the Secretary of the Treasury, the Secretary of Housing and Urban Development,
the Chairman of the Securities and Exchange Commission, the Director of the Federal
Housing Finance Agency, and the Chairman of the Federal Reserve Board. We have met
four times, reviewing the operational plans and policy initiatives of the TARP and discussing
possible additional steps that might be taken. Officers for the Oversight Board have been
appointed, and the Federal Reserve and the other agencies are providing staff support for
the board. Minutes of each meeting are being posted to a special website established by the
Treasury.1 In addition, staff members of the agencies whose heads are participating in the
Oversight Board have met with staff from the Government Accountability Office to explore
strategies for coordinating the oversight that the two bodies are required to perform under the
enabling legislation.
The value of the TARP in promoting financial stability has already been demonstrated. The
financial crisis intensified greatly in the latter part of September and spread to many
countries that had not yet been touched by it, which led to grave concerns about the stability
of the global financial system. Failure to prevent an international financial collapse would
almost certainly have had dire implications for both the U.S. and world economies.
Fortunately, the existence of the TARP allowed the Treasury to react quickly by announcing
a plan to inject $250 billion in capital into U.S. financial institutions. Nine large institutions
received the first $125 billion, and the remainder is being made available to other banking
organizations through an application process. In addition, the Federal Deposit Insurance
Corporation announced that it would guarantee non-interest-bearing transaction accounts at
depository institutions and certain other liabilities of depository institutions and their holding
companies, and the Federal Reserve expanded its provision of backstop liquidity to the
financial system. These actions, together with similar measures in many other countries,
appeared to stabilize the situation and to improve investor confidence in financial firms.
Notably, spreads on credit default swaps for large U.S. banking organizations, which had
widened substantially over the previous few weeks, declined sharply on the day of the joint
announcement. Going forward, the ability of the Treasury to use the TARP to inject capital
into financial institutions and to take other steps to stabilize the financial system - including
any actions that might be needed to prevent the disorderly failure of a systemically important
financial institution - will be critical for restoring confidence and promoting the return of credit
markets to more normal functioning.
As I noted earlier, the Federal Reserve has taken a range of policy actions to provide liquidity
to the financial system and thus promote the extension of credit to households and
businesses. Our recent actions have focused on the market for commercial paper, which is
an important source of short-term financing for many financial and nonfinancial firms.
Normally, money market mutual funds are major lenders in the commercial paper markets.
However, in mid-September, a large fund suffered losses and heavy redemptions, causing it
to suspend further redemptions and then close. In the next few weeks, investors withdrew
almost $500 billion from prime money market funds. The funds, concerned about their ability
to meet further redemptions, began to reduce their purchases of commercial paper and limit
the maturity of such paper to only overnight or other very short maturities. As a result,
interest rate spreads paid by issuers on longer-maturity commercial paper widened
significantly, and issuers were exposed to the costs and risks of having to roll over
increasingly large amounts of paper each day.
The Federal Reserve has developed three programs to address these problems. The first
allows money market mutual funds to sell asset-backed commercial paper to banking
organizations, which are then permitted to borrow against the paper on a non-recourse basis
from the Federal Reserve Bank of Boston. Usage of that facility peaked at around $150
billion. The facility contributed importantly to the ability of money funds to meet redemption
pressures when they were most intense and remains available as a backstop should such
pressures reemerge.
The second program involves the funding of a special-purpose vehicle that purchases highly
rated commercial paper issued by financial and nonfinancial businesses at a term of three
months. This facility has purchased about $250 billion of commercial paper, allowing many
firms to extend significant amounts of funding into next year.
A third facility, expected to be operational next week, will provide a liquidity backstop directly
to money market mutual funds. This facility is intended to give funds confidence to extend
significantly the maturities of their investments and reduce over time the reliance of issuers
on sales to the Federal Reserve's special-purpose vehicle. All of these programs, which were
created under section 13(3) of the Federal Reserve Act, must be terminated when conditions
in financial markets are determined by the Federal Reserve to no longer be unusual and
exigent.
The primary objective of these and other actions we have taken is to stabilize credit markets
and to improve the access to credit of businesses and households. There are some signs
that credit markets, while still quite strained, are improving. Interbank short-term funding
rates have fallen notably since mid-October, and we are seeing greater stability in money
market mutual funds and in the commercial paper market. Interest rates on higher-rated
bonds issued by corporations and municipalities have fallen somewhat, and bond issuance
for these entities rose a bit in recent weeks. The ongoing capital injections under the TARP
are continuing to bring stability to the banking system and have reduced some of the
pressure on banks to deleverage, two critical first steps toward restarting flows of new credit.
However, overall, credit conditions are still far from normal, with risk spreads remaining very
elevated and banks reporting that they continued to tighten lending standards through
October. There has been little or no bond issuance by lower-rated corporations or
securitization of consumer loans in recent weeks.
To help address the tightness of credit, on November 12 the federal banking agencies issued
a joint statement on meeting the needs of creditworthy borrowers. The statement took note of
the recent strong policy actions designed to promote financial stability and improve banks'
access to capital and funding. In light of those actions, which have increased the capacity of
banks to lend, it is imperative that all banking organizations and their regulators work
together to ensure that the needs of creditworthy borrowers are met in a manner consistent
with safety and soundness. As capital adequacy is critical in determining a banking
organization's ability and willingness to lend, the joint statement emphasizes the need for
careful capital planning, including setting appropriate dividend policies. The statement also
notes the agencies' expectation that banking organizations should work with existing
borrowers to avoid preventable foreclosures, which can be costly to all involved - the
borrower, the lender, and the communities in which they are located. Steps that should be
taken in this area include ensuring adequate funding and staffing of mortgage servicing
operations and adopting systematic, proactive, and streamlined mortgage loan modification
protocols aimed at providing long-term sustainability for borrowers. Finally, the agencies
expect banking organizations to conduct regular reviews of their management compensation
policies to ensure that they encourage prudent lending and discourage excessive risk-taking.
Thank you. I would be pleased to take your questions.