U.S. financial model can be fixed: Bernanke
JOANNE MORRISON Reuters April 10, 2008 RICHMOND, Va. — U.S. and international financial system overseers need to put in place soon reforms to restore confidence in markets disrupted by a credit crisis, Federal Reserve Chairman Ben Bernanke said Thursday. The process of making changes is complicated by the ongoing crisis, Mr. Bernanke told the World Affairs Council. “We do not have the luxury of waiting for markets to stabilize before we think about the future,” he said. “Indeed, many of the necessary changes that have been identified, including increased transparency, improving risk management, and attaining better coordination among regulators, could provide important support to the process of normalizing our financial markets,” he said. Mr. Bernanke spoke as finance ministers and central bank heads of 7 major nations known as the Group of Seven gathered for semi-annual meetings in Washington, where they are expected to propose steps to respond to the crisis, which has spread beyond the borders of the United States. Mr. Bernanke, head of the U.S. central bank, acknowledged in response to questions that the economic crisis may be the most severe the United State has faced since the Second World War. At the same time, he said the current slowdown is nothing like the Great Depression of the 1930s, in part because the Fed is far more proactive. Mr. Bernanke, whose academic studies have focused on the Great Depression, said during that era the central bank allowed banks to fail, prices to fall and the money supply to contract, which contributed to the protracted slump. “We now know the lessons from that,” Mr. Bernanke said. “We are certainly going to make sure that the financial system remains in good functioning order.” But the Fed chairman said the U.S. economy is in a bind because as financial institutions respond to the crisis by shoring up their balance sheets and boosting capital, they are withdrawing from their regular function of extending credit, damping economic activity.
1
“The interests of the financial system, the individual firms, are in some sense opposed to the interests of the broader economy,” Mr. Bernanke said in response to questions after his speech. Failures along the chain of extending credit are at the root of the current crisis, but the approach remains effective and should endure with reforms, he said. The U.S. credit system, known as originate-to-distribute, ”broke down at a number of key points, including at the stages of underwriting, credit rating, and investor due diligence,” Mr. Bernanke said. At the same time, financial institutions were tripped up by inadequate risk management and liquidity planning, he said. “These problems notwithstanding, the originate-to-distribute model has proven effective in the past and with adequate repairs could be so again in the future,” he said. In that credit model, one entity makes a loan to a borrower, assessing that individual's credit-worthiness and ability to repay. The loan is then sold to an institution, which bundles it with other loans to create a security, which is in turn sold to investors. “The spreading of risk that was supposed to be one of the benefits of the originate-todistribute model proved to be much less extensive than many believed,” Mr. Bernanke said. The Fed chairman did not comment on the outlook for the U.S. economy or interest rates in the text of his speech. Mr. Bernanke told Congress last week that a recession is possible as the United States weathers a deep correction in the once-booming housing market and a credit crunch paralyzing credit markets.
2