Ben S Bernanke: Developments in the financial markets
Testimony of Mr Ben S Bernanke, Chairman of the Board of Governors of the US Federal
Reserve System, before the Committee on Banking, Housing, and Urban Affairs, US Senate,
Washington DC, 3 April 2008.
* * *
Chairman Dodd, Senator Shelby, and other members of the Committee, I appreciate this
opportunity to discuss current economic and financial conditions and the actions the Federal
Reserve has taken to stabilize financial markets and the economy.
Although the situation has recently improved somewhat, financial markets remain under
considerable stress. Pressures in short-term bank funding markets, which had abated
somewhat beginning late last year, have increased once again. Many lenders have been
reluctant to provide credit to counterparties, especially leveraged investors, and increased
the amount of collateral they required to back short-term security financing agreements. To
meet those demands, investors have reduced their leverage and liquidated holdings of
securities, putting further downward pressure on security prices. Credit availability has also
been restricted because some large financial institutions, including some commercial and
investment banks and the government-sponsored enterprises (GSEs), have reported
substantial losses and writedowns, reducing their capital available to support increased
lending. Some key securitization markets, including those for nonconforming mortgages,
continue to function poorly if at all.
These developments in financial markets - which themselves reflect, in part, greater
concerns about housing and the economic outlook more generally - have weighed on real
economic activity. Notably, in the housing market, sales of both new and existing homes
have generally continued weak, partly as a result of the reduced availability of mortgage
credit, and home prices have continued to fall. Private payroll employment fell substantially in
February, after two months of smaller job losses, with job cuts in construction and closely
related industries accounting for a significant share of the decline. But the demand for labor
has also moderated recently in other industries. Overall, the near-term economic outlook has
weakened relative to the projections released by the Federal Open Market Committee
(FOMC) at the end of January. Inflation has also been a source of concern. We expect
inflation to moderate in coming quarters, but it will be necessary to continue to monitor
inflation developments carefully.
Well-functioning financial markets are essential for the efficacy of monetary policy and,
indeed, for economic growth and stability. Consistent with its role as the nation's central
bank, the Federal Reserve has taken a number of steps in recent weeks to improve market
liquidity and market functioning. These actions include reducing the cost and increasing the
allowable term of discount window credit to commercial banks; increasing the size of our
Term Auction Facility, through which credit is auctioned to depository institutions; initiating a
Term Securities Lending Facility, which allows primary dealers to swap less-liquid mortgage
backed securities for more-liquid Treasury securities; and creating the Primary Dealer Credit
Facility, which is similar to the discount window but accessible to primary dealers. Although
these facilities operate through depository institutions and primary dealers, they are designed
to support the broader financial markets and the economy by facilitating the provision of
liquidity by those institutions to their customers and counterparties. With respect to monetary
policy, at its March meeting the FOMC reduced its target for the federal funds rate by 75
basis points to 2-1/4 percent.
It was in this context of intensifying financial strains that, on March 13, Bear Stearns advised
the Federal Reserve and other government agencies that its liquidity position had
significantly deteriorated and that it would have to file for bankruptcy the next day unless
alternative sources of funds became available.
This news raised difficult questions of public policy. Normally, the market sorts out which
companies survive and which fail, and that is as it should be. However, the issues raised
here extended well beyond the fate of one company. Our financial system is extremely
complex and interconnected, and Bear Stearns participated extensively in a range of critical
markets. The sudden failure of Bear Stearns likely would have led to a chaotic unwinding of
positions in those markets and could have severely shaken confidence. The company's
failure could also have cast doubt on the financial positions of some of Bear Stearns'
thousands of counterparties and perhaps of companies with similar businesses. Given the
exceptional pressures on the global economy and financial system, the damage caused by a
default by Bear Stearns could have been severe and extremely difficult to contain. Moreover,
the adverse impact of a default would not have been confined to the financial system but
would have been felt broadly in the real economy through its effects on asset values and
credit availability.
To prevent a disorderly failure of Bear Stearns and the unpredictable but likely severe
consequences for market functioning and the broader economy, the Federal Reserve, in
close consultation with the Treasury Department, agreed to provide funding to Bear Stearns
through JPMorgan Chase. Over the following weekend, JPMorgan Chase agreed to
purchase Bear Stearns and assumed Bear's financial obligations.
The purpose of our action, as with our other recent actions - including our provision of
liquidity to financial firms and our reductions in the federal funds rate target - was, as best as
possible, to improve the functioning of financial markets and to limit any adverse effects of
financial turmoil on the broader economy. We will remain focused on those objectives.
Clearly, the U.S. economy is going through a very difficult period. But among the great
strengths of our economy is its ability to adapt and to respond to diverse challenges. Much
necessary economic and financial adjustment has already taken place, and monetary and
fiscal policies are in train that should support a return to growth in the second half of this year
and next year. I remain confident in our economy's long-term prospects.
Thank you. I would be pleased to take your questions.