US Fed sees some healing in scarred credit markets
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Top US Federal Reserve officials have cited progress in alleviating months of turmoil in financial markets, but have said a full return to normalcy was still some time away.
The recent credit woes underscore the need for banks to hold "generous" capital cushions, US Federal Reserve Chairman Ben Bernanke said, as he urged banks to actively raise money and prepare for better times that lie ahead.
"I strongly urge financial institutions to remain proactive in their capital-raising efforts," Mr Bernanke said in a speech at the Chicago Fed's 44th annual bank structure conference.
This year's theme is "Credit Market Turmoil: Causes, Consequences and Cures".
"Doing so not only helps the broader economy but positions firms to take advantage of new profit opportunities as conditions in the financial markets and the economy improve," he said.
Mr Bernanke and the New York Fed's William Dudley, who oversees financial markets for the US central bank, provided plenty of grist for the analysis mill.
Fed watchers believe that the Fed is pushing banks to redouble efforts to get past the months-long credit crisis, just as the Fed has raised its own game, innovating ways to bolster market liquidity when it was desperately needed.
Cary Leahey, an economist with Decision Economics in New York, said Mr Bernanke was urging banks to redouble their efforts to get rid of less productive assets so that they can resume more normal lending patterns.
"The Fed thinks it has done a lot to ease the credit crisis and now the financial institutions have to pick up the ball and run with it," Mr Leahey said.
Mr Bernanke said the success of many banks in raising new capital has been encouraging, and praised the often contentious foreign-owned sovereign wealth funds for their role in supplying capital in a time of need.
"They have generally provided unleveraged, patient money, which is what is needed here. They have not asked for extensive control or management of the firms," the Fed chairman said.
Raising capital and repairing balance sheets will "allow for the extension of new credit, which supports economic expansion," he added.
Asset bubbles
At the Chicago Fed's conference a year ago, Mr Bernanke said he expected little spillover from problems in subprime mortgages to the broader economy.
In hindsight, Mr Bernanke said it was evident that "problems occurred at each step of the credit-extension chain," and had contributed to the credit crisis that has driven the economy to the brink of recession.
In Philadelphia, Fed Governor Frederic Mishkin has said central banks can do more harm than good when they try to use interest rates to pop the type of asset price bubbles that led to the current crisis.
"Not all asset price bubbles are alike," he said.
But he added that financial regulators may be able to prevent the market failures that often inflate such bubbles.
With monetary policy focused on ensuring price stability and sustainable employment, "it falls to regulatory policies and supervisory practices to help strengthen the financial system and reduce its vulnerability to both booms and busts in asset prices," he said.
Interesting times
The New York Fed's Mr Dudley, the central bank's money market operations guru, spoke about the credit crisis for the first time since October, in comments titled, "May You Live in Interesting Times: The Sequel".
Contrary to a recent study by two leading economists, Mr Dudley said the evidence suggests that the Fed's lineup of new emergency lending facilities has improved financial market functions in recent months.
Still, problems in the banking sector will not be easily worked through, Mr Dudley said.
"It will take time for market function to return to normal. The reintermediation and deleveraging process has, in my view, a considerable ways to go," he said.
The Fed's willingness to provide liquidity against less liquid collateral has smoothed out and extended, but not prevented, the credit market's shakeout, he said.
Smoother or not, the credit crisis that was brewing in early 2007, and hit with hurricane force last August, has pushed the United States economy to the brink of recession.
Mr Dudley said that the recent widening in certain interest rate spreads suggested "increased balance sheet pressure on banks."
If so, the Fed can only do so much to help.
"There are limits to what the Federal Reserve can accomplish in terms of narrowing such funding spreads. After all, the Fed's actions cannot create bank capital or ease balance sheet constraints materially," he said.
-Reuters
