Bernanke Tells Congress That Fed Has Exit Strategy

 

Wednesday, Jul 22,2009, 11:16:42 AM   Click:

Federal Reserve Chairman Ben Bernanke on Tuesday defended the skepticism of the Congress of the Fed on an extension of its functions to the police major financial firms since the failure of the central bank to take the problems that led to the financial crisis .

Bernanke has also faced some grilling from the House Financial Services Committee on the taxpayer rescue of financial firms, the slow pace of efforts to curb the movement seized homes and concerns about the Fed's history of protecting consumers against abusive lending practices, credit card companies and other financial service providers.

"The Fed has made some big mistakes," said the senior Republican Spencer Bachus of Alabama. Let the Fed become the financial Supercop would just invite a false sense of security "that would be undermined at the expense of taxpayers, he warned.

Bernanke argued that the Obama administration's proposal would be a "modest reorientation" of the Fed's powers, not a great expansion of them.

The Fed chief also sought to beat back an administration proposal that would create a new consumer protection regulator for financial services and strip some of those duties from the central bank.


Consumer groups and lawmakers have blamed the Fed for not cracking down early on dubious mortgages practices that fed the housing boom and figured into its collapse. Later this week, the Fed will issue a proposal boosting disclosures on mortgages and home equity lines of credit. It also will include new rules governing the compensation of mortgage originators.

Bernanke urged Congress to keep proposals to audit the Fed away from monetary policy duties. "A perceived loss of monetary policy independence could raise fears about future inflation," he warned.

Bernanke's term expires early next year, and President Barack Obama will have to decide whether to reappoint him. The Fed chief's innovative policies have been credited with pulling the economy from the edge of the abyss last year. But those actions also have touched off criticism about putting taxpayers at risk and whether the government should be cleaning up Wall Street messes.

Bernanke sought to assure investors and Congress that the Fed will be able to reel in its extraordinary economic stimulus and prevent a flare up of inflation when the recovery is more firmly rooted.

Any such steps will be far off in the future and the central bank's focus remains "fostering economic recovery," he said.

To that end, Bernanke again pledged to keep its key bank lending rate at a record low near zero for an "extended period." Economists predict rates will stay at record lows through the rest of this year.

Laying out a plan now to unwind the Fed's stimulus may give Bernanke more leeway to hold rates at record lows to brace the economy. That's because doing so could tamp down investors' fears that the Fed's aggressive actions to lift the country out of its longest recession since World War II could spur inflation later on.

"It is important to assure the public and the markets that the extraordinary policy measures we have taken in response to the financial crisis and the recession can be withdrawn in a smooth and timely manner as needed, thereby avoiding the risk that policy stimulus could lead to a future rise in inflation," Bernanke said. "We are confident that we have the necessary tools to implement that strategy when appropriate."

To revive the economy, the Fed has plowed trillions into the financial system in an effort to drive down rates on mortgages and other consumer debt. It also has created programs to bust through credit clogs, a key ingredient to turning the economy around.

When the time comes, the Fed will need to soak up that money.

Besides raising its key bank lending rate, the Fed can raise the rate it pays banks on reserve balances held at the central bank, Bernanke said. That would give banks an incentive to keep their money parked there, rather having it flow back into the financial system, where it can stoke inflationary pressures. The Fed also can drain money from the financial system by selling securities from its portfolio with an agreement to buy them back at a later date or it can sell securities outright.

Steering the economy from recession to recovery will be a delicate move for Bernanke economically and politically.

On the economic front, Bernanke repeated the Fed's forecast that the economy should start growing again in the second half of this year, but he warned growth would be slight, leading to higher unemployment.


Despite some improvements including a stabilization in consumer spending and moderating declines in housing activity the economy remains vulnerable, he said.