Statement by Federal Reserve Chairman Ben Bernanke STATEMENT BY FEDERAL RESERVE CHAIRMAN BEN BERNANKE CNBC.com | 18 Nov 2008 | 09:54 AM ET
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 1 See U.S. Department of the Treasury, Emergency Economic Stabilization Act website, www.ustreas.gov/initiatives/eesa.
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 mounts 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 reventable 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.
Testimony by Treasury Secretary Henry Paulson TESTIMONY BY TREASURY SECRETARY HENRY PAULSON CNBC.com | 18 Nov 2008 | 09:54 AM ET
Good morning and thank you for the opportunity to testify this morning on implementation of the Emergency Economic Stabilization Act. I am grateful and everyone in this country should be grateful, for the efforts of Chairman Frank, ranking member Bachus, this committee and other members of Congress toward adoption of the financial rescue legislation, which created critically important authorities and financial capacity to stabilize our financial system.
Before Congress provided these tools, we were facing a financial crisis without the authorities and resources necessary to meet the challenge. At the risk of oversimplification, the financial rescue package is about restoring confidence—restoring the confidence of depositors and investors in our financial institutions, and restoring the confidence that our financial institutions need so that they will get back to normal lending practices.
This law has already allowed us to take decisive action to prevent the collapse of our financial system. But more needs to be done, and it is my responsibility to use the authorities Congress provided to protect and strengthen the financial system, and in so doing, protect the taxpayer.
Let me summarize what the U.S. financial system has had to digest in just a few months' time. We have not in our lifetime dealt with a financial crisis of this severity and unpredictability. We have seen the failures, or the equivalent of failures, of Bear Stearns, IndyMac Bank, Lehman Brothers, Washington Mutual, Wachovia, Fannie Mae, Freddie Mac, and AIG—institutions with a collective $4.7 trillion in assets when this year began.
Each of these failures would be tremendously consequential in their own right under normal market conditions—but our economy and our financial system faced them in succession while at the same time the economy was weakening. Other large financial institutions were under significant pressure and market participants around the world were speculating about which institution would be next to fall.
And as you well recall, in September, after 13 months of market stress, the financial system essentially seized up and we had a system-wide crisis. Our markets were frozen, banks had pulled back very substantially from interbank lending. Confidence in our financial system and a number of our financial institutions had been seriously compromised. That was the background against which Chairman Bernanke and I met with the Congressional bipartisan leadership to explain the need for emergency legislation.
Our objectives in asking Congress for a financial rescue package were to first stabilize a financial system on the verge of collapse, and then to get lending going again to support the American people and businesses. We warned that the frozen credit markets were already severely damaging the U.S. economy and costing jobs. If the financial system were to collapse, it would significantly worsen and prolong the economic downturn that was already underway.
We needed the financial rescue package so we could intervene, stabilize our financial system, and minimize further damage to our economy. The rescue package was not intended to be an economic stimulus or an economic recovery package; it was intended to shore up the foundation of our economy by stabilizing the financial system, and it is unrealistic to expect it to reverse the damage that had already been inflicted by the severity of the crisis.
During the two weeks Congress worked on the legislation, market conditions worsened significantly. Many Americans look at the stock market as an indicator of the economy, and during this period they saw tremendous volatility. The Dow Jones Industrial Average fell more than 700 points on one single day, and over 9 percent during the two weeks the legislation was debated—stock market losses amounted to slightly more than $2 trillion.
But we were focused on the credit markets because they provide our basic economic fuel—borrowing and lending capital - that supports and creates jobs. The confidence in banks and of banks continued to diminish, as did the flow of funds between them. Interbank lending rates relative to policy rates were at the highest level this decade, indicating banks' lack of confidence in one another and in the financial system.
And the problems extended well beyond the banks. Corporate bond spreads continued to increase, as did corporate credit default spreads and overall market volatility. Industrial company access to all aspects of the bond market was dramatically curtailed. For example, blue chip industrial companies were frequently unable to issue commercial paper with maturities greater than a few days as the commercial paper market became severely impaired. We received reports of small and medium-sized companies, with no direct connection to the financial sector, losing access to the normal credit needed to meet payrolls, pay suppliers and buy inventory.
Investor concerns became most evident in the "flight to quality" in the Treasury market, with short-term Treasury bill yields dropping to near zero.
During that same period, the government intervened to protect the financial system. The FDIC acted to mitigate the failure of Washington Mutual by facilitating its sale, and made clear that it would intervene to prevent Wachovia's failure. And turmoil had developed in European markets. In a two-day period at the end of September the governments of Ireland, the UK, Germany, Belgium, France and Iceland intervened to prevent the failure of one or more financial institutions in their countries.
By the time legislation had passed on October 3, the global market crisis was so broad and so severe, we knew we needed to move quickly and take powerful steps to stabilize our financial system and to get credit flowing again. Our initial intent had been to strengthen the banking system by purchasing illiquid mortgages and mortgage-related securities. But by this time, given the severity and magnitude of the situation, an asset purchase program would not be effective enough, quickly enough. Therefore we exercised the authority granted by Congress in this legislation to develop and quickly deploy a $250 billion capital injection program, fully anticipating we would follow that with a program for troubled asset purchases.
There is no playbook for responding to turmoil we have never faced We adjusted our strategy to reflect the facts of a severe market crisis always keeping focused on Congress's goal and our goal - to stabilize the financial system that is integral to the everyday lives of all Americans.
By mid-October, our actions, in combination with the FDIC's guarantee of certain debt issued by financial institutions, helped us to accomplish the first major priority, which was to immediately stabilize the financial system. And, as we worked to hire contractors and prepare our mortgage asset purchase plan for implementation, we continued to assess the economic and market conditions here and around the world.
As we had seen and communicated to Congress and the American people, much damage had already been done to our economy. The economic data since the legislation passed underscored the challenges we were facing: On October 31, third quarter GDP showed negative 0.3 percent growth. Jobs data showed a rise in the unemployment rate to a level not seen in 15 years, and a loss of 240,000 jobs in October alone. Data released on October 28 showed that through August, home prices in 10 major cities had fallen 18 percent over the previous year, demonstrating that the housing correction had not abated.
The slowing of European economies has been even more dramatic, as have the actions taken to rescue failing European banks and nationwide banking systems such as those in Iceland and Hungary.
Throughout this period, we continued to assess how best to use the remaining TARP funds, given the uncertainties around the deteriorating economic situation in the U.S. and globally, and the continuing financial market stresses. We have always said that the housing correction is at the root of the economic downturn and our financial market stress. And as the economy slows further, it threatens to prolong the housing correction, as well as the stress on our financial institutions and financial markets.
We recognized that a troubled asset purchase program, to be effective, would require a massive commitment of TARP funds. It became clear that, while in mid-September, before economic conditions worsened, $700 billion in troubled asset purchases would have had a significant impact. Half of that sum, in a worse economy, simply isn't enough firepower.
If we have learned anything throughout this year we have learned that this financial crisis is unpredictable and difficult to counteract. So early last week, we concluded it was only prudent to reserve our TARP capacity, maintaining not only our flexibility, but that of the next Administration.
We have identified other priorities that I believe the government will need to address through the TARP and other existing authorities. In particular, by investing only a relatively modest share of TARP funds in a Federal Reserve liquidity facility, we can improve securitization in this market and have a significant impact on the availability of consumer credit.
And we need to continue our efforts to use a variety of authorities to reduce avoidable foreclosures. The government has made substantial progress on that front, through HUD programs, through the FDIC's program with IndyMac, through our support and leadership of the HOPE NOW Alliance, and through the new GSE servicer guidelines announced last week that will set a new standard for the entire industry. While I understand the interest in spending TARP resources on other approaches, the efforts already underway will do more to prevent foreclosures than might have been achieved through very large purchases of mortgage-related securities through the TARP.
Although we are not planning to initiate another capital program beyond those already announced, an emphasis on capital seems to us to be the better strategy going forward. In the weeks since enactment of EESA, we have seen that capital purchases are clearly powerful in terms of impact per dollar of investment, which is a major advantage under the current circumstances. More capital enables banks to take losses as they write down or sell troubled assets. And stronger capitalization is also essential to increasing lending which, although difficult to achieve during times like this, is essential to economic recovery.
Our current Capital Purchase Program for banks and thrifts has already dispersed $148 billion, and we are processing many more applications. And yesterday we posted the term sheet for participation for non-publicly traded banks, another important source of credit in our economy. We are developing a matching program for possible future use which could apply to banks and/or non-bank financial institutions.
Recently I've been asked two questions. First, Congress gave you the authorities you requested, and the economy has only gotten worse. What went wrong and why won't you use this authority for other industries? Second, if housing and mortgages are at the root of our economic difficulties, why aren't you addressing this?
The answer to the first is that the purpose of the financial rescue legislation was to stabilize our financial system and to strengthen it. It is not a panacea for all our economic difficulties. The crisis in our financial system had already spilled over into our economy and hurt it. It will take a while to get lending going and repair our financial system, which is essential to an economic recovery. This won't happen as fast as any of us would like, but it will happen much, much faster than it would have had we not used the TARP to stabilize our system. Put differently, if Congress had not given us the authority for TARP and the Capital Purchase Program and our financial system had continued to shut down, our economic situation would be far worse today.
The answer to the second question is that the most important thing we can do to mitigate the housing correction and reduce the number of foreclosures is to increase access to lower cost mortgage lending. The actions we have taken to stabilize and strengthen Fannie Mae and Freddie Mac, and through them to increase the flow of mortgage credit, together with our bank capital program, are powerful actions to promote mortgage lending. We are also working actively to reduce preventable foreclosures.
In summary, I am very proud of the decisive actions by Treasury, the Fed and the FDIC to stabilize our financial system. We have done what was necessary as facts and conditions in the market and economy have changed, adjusting our strategy to most effectively address the urgent crisis and preserving the flexibility of the President-elect and the new Secretary of the Treasury to address the challenges in the economy and capital markets they will face in the coming months.
While difficult challenges lie ahead, the new administration will begin with two significant advantages: a significantly more stable banking system where the failure of a systemically relevant institution is no longer a pressing concern rattling the markets; and the resources, authorities, and potential programs available to deal with the future capital and liquidity needs of credit providers. Deploying these new tools and programs to restore our financial institutions and financial markets is critical to restoring the flow of lending and credit - which will determine, to a large extent, the speed and trajectory of our economic recovery. I am confident in a successful outcome, because our economy is flexible and resilient, rooted in the entrepreneurial spirit and productivity of the American people. And of course, I will focus intensely on the challenges before me and on making this a seamless transition during my remaining nine weeks.
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