The Wall Street Journal
In a sign of continuing worries about the financial system and the economy, Federal Reserve Chairman Ben Bernanke on Tuesday outlined a series of sweeping measures designed to shore up mortgage lending and help markets operate more smoothly.
The proposals, coming less than a year after troubles in the housing sector sparked a global crisis in credit markets, could extend the Fed’s unprecedented role in lending to the nation’s largest investment banks and enhance the central bank’s authority over key aspects of the financial system. The Fed also will release revamped policies next week to prohibit some mortgage-lending practices that spawned the recent troubles.
Mr. Bernanke is walking a difficult line. Extending the lending program for investment banks would show the Fed is still worried about the state of the financial system. At the same time, it is also under pressure to raise interest rates to clamp down on inflation, which could worsen problems for the financial sector and weigh down an economy hit by falling home values, tightening credit and rising fuel costs.
Mr. Bernanke’s signal that the Fed could extend its lending into next year helped push stocks higher. The Dow Jones Industrial Average, which was volatile throughout the day, rose 152.25 points to close at 11,384.21, supported by gains in the financial sector. Shares of government-sponsored mortgage companies Fannie Mae and Freddie Mac — whose stocks had been battered Monday by concerns about their financial condition — each rose more than 10% after their regulator allayed fears that the firms would have to raise large amounts of capital.
In his speech, delivered at a Federal Deposit Insurance Corp. conference in Arlington, Va., Mr. Bernanke said for the first time that the Fed’s temporary lending program to investment banks could be extended into 2009 “should the current unusual and exigent circumstances continue to prevail” in the funding markets for securities dealers.
The program, known as the primary-dealer credit facility, was created in March following the near-collapse of Bear Stearns Cos. and was scheduled to expire in mid-September. It extended to investment banks loans the Fed had long offered to commercial banks.
It has taken the central bank into uncharted territory in its role as lender to institutions it doesn’t regulate. Officials at the Fed and Treasury Department disagree about who should have long-term responsibility for particular parts of the financial system, and continue to debate the wisdom of extending the central bank’s new lending programs.
“On an emergency basis, what they did with Bear Stearns was appropriate,” said University of Michigan law professor Michael Barr, an expert on financial institutions. “They didn’t really have a choice. The additional lending facility to investment banks needs to be contingent on real supervisory and enforcement authority over the investment banks. They don’t currently have that.”
The Treasury has proposed that the central bank be given more responsibility to oversee the stability of the financial system, but the Fed is leery of accepting such a role without also receiving a boost to its regulatory powers. The Fed is also looking to monitor more closely the investment banks to which it now lends money.
The potential accumulation of power by the central bank worries some at Treasury, according to a person familiar with the matter. The Fed’s direct bank supervision, coupled with its authority as the lender of last resort and its overall responsibility for financial-market stability, concentrates a lot of power in one entity, this person said. The concern is that the Fed, as an individual regulator, might have an incentive to keep a firm from failing, even if failure is the most appropriate option.
Even some Fed insiders have criticized the central bank’s new lending programs, warning they could distort markets and encourage risky behavior by firms that believe the government will back them up in crisis. Last month, Federal Reserve Bank of Richmond President Jeffrey Lacker said the new programs and other recent actions “have gone beyond previously accepted boundaries” by directing credit toward particular sectors.
On Tuesday, Mr. Lacker said he doesn’t have “strong feelings” about whether the lending to investment banks should continue for a longer period. He downplayed concerns that its removal might exacerbate the sector’s troubles. “I don’t think that’s a strong danger,” he said.
Investment banks have cut back their use of the borrowing tool sharply in recent weeks. Average daily borrowing in the week through last Wednesday was $1.7 billion. In early April the daily average rose as high as $38.1 billion.
Top Fed officials have maintained that the existence of the program may alleviate strains if firms and markets know the lending window is available as a backstop.
Mr. Bernanke acknowledged that lending to investment banks “could tend to make market discipline less effective in the future. Going forward, the regulation and supervision of these institutions must take account of these realities.”
Because it is lending directly to investment banks, Fed officials are stationed inside the nation’s four biggest firms and working alongside officials from the Securities and Exchange Commission, which now has the responsibility for regulating investment banks. Both agencies agreed on a pact this week to share information and collaborate in setting capital requirements for investment banks. Mr. Bernanke said the agencies are taking steps to “increase the firms’ capital and liquidity buffers.”
For homeowners, Mr. Bernanke said the Fed would release much-anticipated rules next week that would prohibit certain mortgage practices the central bank deems “unfair” or “deceptive.” He suggested the final rules would be changed some from a proposal made in December. Among other things, the proposal would ban lenders from originating mortgages “in a pattern or practice” that doesn’t take into account a borrower’s ability to make payments in most cases.
Treasury Secretary Henry Paulson, speaking Tuesday at the same event, did not comment directly on proposals to redraw the Fed’s supervisory powers. He is expected to weigh in on these issues at a House Financial Services Committee hearing Thursday alongside Mr. Bernanke. But he did suggest that some congressional proposals to jump-start housing markets — particularly with government money — wouldn’t work, reinforcing the divide between Democrats and the Bush administration.
“I don’t see a good result to come out of somehow injecting more public money into trying to prevent a correction in the housing market that is inevitable, or in looking to somehow or other keep people in homes if they can’t afford to stay in their homes,” Mr. Paulson said.
‘The Price You Pay’
Wall Street executives said they weren’t surprised the Fed may keep lending to investment banks, considering the market’s fragility.
“Everybody expects there will be some new rules that come with it; that’s the price you pay,” one Wall Street executive said.
In June, Merrill Lynch & Co. Chairman and Chief Executive John Thain said he favored extending the lending program to restore confidence to the markets. While Merrill has tested it, it has not used it as a source of cash for day-to-day operations. Lehman Brothers hasn’t used the program since April but also favors keeping it open, according to people close to the firm.
Goldman Sachs Group Inc., which hasn’t been battered as badly by the credit crunch as its Wall Street rivals, also believes it makes sense to keep the Fed window open to investment banks in order to calm market jitters, according to a person familiar with the situation.
Goldman and Morgan Stanley also have tested the program so that they’d know how to use it should the need arise.