Tags: Ben Bernanke

Bernanke Defends Fed's Liquidity Measures

By , Money Morning •

By Jennifer Yousfi
Managing Editor

The U.S. Federal Reserve will make sure the global financial markets have sufficient liquidity to operate effectively and will increase the size of its government bond auctions if additional capital is needed, central bank Chairman Ben S. Bernanke said today (Tuesday).

Speaking via satellite at the Atlanta Financial Markets Conference in Sea Island, Georgia, the Fed chairman said he sees some signs of improvement in the financial markets, but noted that  "at this stage conditions in financial markets are still far from normal."

In his speech, Bernanke outlined the steps the central bank has taken to help mitigate a credit crunch that was spawned by a historically weak housing market, and to offset at least some of the damage that's been caused by a subprime-mortgage crisis that has riddled the worldwide financial-services sector.

In fact, Bernanke made a special effort to underscore the global nature of the crisis, and to emphasize the need for worldwide cooperation on solutions.

"The financial distress since August has also underscored the importance of international cooperation among central banks," he said. "For some time, central banks have recognized that managing crises involving large financial institutions operating across national borders and in multiple currencies can present difficult challenges. Funding pressures can easily arise in more than one currency and in more than one jurisdiction. In such cases, central banks may find it essential to work closely together."

And while he made it clear that part of the Fed's role was to help maintain liquidity in the markets, Bernanke also preached the importance of balance, cautioning against extreme overly aggressive measures.

"Central banks should give careful consideration to their criteria for invoking extraordinary liquidity measures," he said.

He warned that if financial institutions come to believe that the Fed is always standing ready to come to the rescue, then those same institutions and their creditors have "less incentive to pursue suitable strategies for managing liquidity risk and more incentive to take such risks."

"A central bank that is too quick to act as a liquidity provider of last resort risks inducing moral hazard," Bernanke said.

Views like that are a big reason that both Bernanke and the Federal Reserve have been criticized for what some saw as a government-sponsored bailout of strapped-for-cash investment bank, The Bear Stearns Cos. Inc. (BSC), in mid-March.

Bernanke's speech didn't address the aggressive rate-cutting campaign central bank policymakers launched last September. And he also made no mention of the next meeting of the policymaking Federal Open Market Committee (FOMC), which is set for June 24-25.

At its last meeting, the FOMC voted to lower the benchmark Federal Funds rate 25 basis points to its current level of 2.0%. It was the Fed's seventh rate cut since September when the key interest rate stood at 5.25%.

Language in the FOMC statement that accompanied that rate-reduction order led some analysts to expect the Fed to remain on pause throughout the summer. That would provide the prior rate cuts time to work their way through the financial system. The belief that the interest-rate reductions were finished, for now, has helped the dollar, which has been weakened by the rate cuts, to rally.

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