Financial Storm Is Still Blowing: Bernanke

Source : The Business Times, August 23, 2008

Fed working on three fronts to maintain economic stability, says US central bank chief

(WASHINGTON) US Federal Reserve chairman Ben Bernanke said yesterday the financial storm that began last year 'has not yet subsided', creating 'one of the most challenging' economic environments in memory.

Mr Bernanke: A commodity-fuelled surge in inflation is complicating the efforts to prop up the economy

In comments to the Fed's annual symposium in Jackson Hole, Wyoming, Mr Bernanke said economic conditions remain soft as unemployment is rising and inflation pressures remain hot.

The mix has created 'one of the most challenging economic and policy environments in memory', Mr Bernanke said, according to a text of his remarks released by the central bank.

Mr Bernanke said the Fed has been working on three fronts in an effort to maintain economic stability - keeping interest rates low to prevent a collapse of economic activity, offering extra liquidity to banks and brokerages facing a credit squeeze, and revamping the regulatory structure to prevent a recurrence of the housing boom-bust cycle.

'By cushioning the first- round economic impact of the financial stress, we hoped also to minimise the risks of a so-called adverse feedback loop in which economic weakness exacerbates financial stress, which, in turn, further damages economic prospects,' he said.

Yet Mr Bernanke said the efforts to prop up the economy are complicated by a commodity-fuelled surge in inflation.

But he said the Fed's strategy 'has been conditioned on our expectation that the prices of oil and other commodities would ultimately stabilise, in part as the result of slowing global growth'.

He said the Fed's extraordinary efforts to pump liquidity into the financial system were 'intended to mitigate what have been, at times, very severe strains in short-term funding markets and, by providing an additional source of financing, to allow banks and other financial institutions to deleverage in a more orderly manner'.

Mr Bernanke said the Fed and government authorities are looking at more comprehensive regulatory overhauls to help avert further crises and stabilise the financial system.

This means moving beyond the banking system that is closely regulated by the Fed and having tighter rules for investment firms and brokerages that allows regulators to potentially step in and take control in a manner similar to that of a failed bank.

He said the rescue of Bear Stearns, in which the Fed and Treasury helped the failing firm's buyout by JPMorgan Chase, 'was severely complicated by the lack of a clear statutory framework' and that Congress should consider such a framework.

'A statutory resolution regime for non-banks, besides reducing uncertainty, would also limit moral hazard by allowing the government to resolve failing firms in a way that is orderly but also wipes out equity holders and haircuts some creditors, analogous to what happens when a commercial bank fails,' the Fed chief said.

He said another point to consider is 'a more fully integrated overview of the entire financial system', which he said 'has become less bank-centred'.

Earlier yesterday, billionaire investor Warren Buffett said the US economy is unlikely to improve before 2009, and that he expects the government to take action to support troubled mortgage financiers Fannie Mae and Freddie Mac.

Speaking on CNBC television, Mr Buffett said retail businesses within his Berkshire Hathaway Inc, insurance and investment conglomerate have been struggling and that the economy is now suffering from past excesses in the availability of credit.

'You always find out who's been swimming naked when the tide goes out. We found out that Wall Street has been kind of a nudist beach,' said Mr Buffett, the world's richest person, according to Forbes magazine. -- AFP, Reuters