Bernanke Says Fed May Continue Lending Into Next Year

July 8 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke, seeking to allay renewed concerns over the health of the nation's financial system, said the central bank may extend its emergency-loan program for investment banks into next year.

``The Federal Reserve is strongly committed'' to financial stability and is ``considering several options, including extending the duration of our facilities for primary dealers beyond year-end,'' Bernanke said in a speech to a conference in Arlington, Virginia.

The Fed chairman's comments, the first time he has indicated how long he'll extend the lending programs, come a day after an index of bank shares reached its lowest level since 1996.

Bernanke also endorsed proposals to set up a federal liquidation process for a failing investment bank. The Treasury should ``take a leading role in any such process'' in consultation with regulators, he said. Such a resolution mechanism may help reduce concern that investors and dealers begin counting on Fed aid in case their bets go wrong.

The Fed started the unprecedented lending programs for investment banks in March under its authority to lend to nonbanks in ``unusual and exigent circumstances.'' Officials said at the time the Primary Dealer Credit Facility, which provides direct loans, would last for ``at least'' six months.

Rate Outlook

Continued lending to investment banks may make it harder for the Fed to raise interest rates this year. Traders estimate 74 percent odds of at least quarter point increase in the 2 percent benchmark rate by year-end.

``There was some speculation that, come September,'' the lending programs ``might be allowed to expire,'' Dominic Konstam, head of interest-rate strategy at Credit Suisse Securities USA LLC in New York, said in a Bloomberg Radio interview. ``A lot of people would have thought that might be a prelude to the Fed beginning a tightening cycle. Now, that is obviously that much more uncertain.''

The Standard & Poor's 500 Banks Index, a measure of 22 firms including Fannie Mae and Freddie Mac, the largest sources of U.S. home financing, fell to 155.48 yesterday, its lowest level since 1996.

The Fed chairman didn't comment on the outlook for the economy or monetary policy in his remarks today to a Federal Deposit Insurance Corp. forum on mortgage lending. Treasury Secretary Henry Paulson and JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon are also scheduled to speak at the event.

The PDCF and the Fed's Term Securities Lending Facility, which auctions as much as $200 billion in Treasuries are both aimed at the 20 primary dealers in U.S. government debt.

Capital `Buffers'

The Fed is working with the Securities and Exchange Commission and securities dealers ``to increase the firms' capital and liquidity buffers,'' Bernanke said.

Securities firms have cut back on their use of the programs in recent weeks. The balance of loans outstanding from the PDCF dropped to zero as of July 2, the first time that's happened since the program began. On March 26, the end of the first full week of operation, the PDCF had a balance of $37 billion.

Bids in the TSLF's weekly auctions, in which dealers swap securities such as mortgage-backed debt for Treasuries from the New York Fed, have declined since the start of the program. In the July 3 operation, firms submitted bids for $26.1 billion out of $50 billion of Treasuries offered.

Financial Strains

One gauge of financial stress watched by the Fed has remained elevated. The difference between the overnight indexed swap rate, a measure of what traders expect for the Fed's benchmark rate, and three-month interbank loans in dollars was 0.78 percentage point yesterday, about the same as the start of May.

``Although short-term funding markets remain strained, they have improved somewhat since March,'' Bernanke said.

Bernanke's comments on the resolution authority are in line with Treasury Secretary Henry Paulson's July 2 statement that ``any commitment of government support should be an extraordinary event that requires the engagement of the executive branch.''

FDIC Chairman Sheila Bair has also said an agency should be given such liquidation authority for investment banks. The FDIC has that power over lenders whose deposits it insures. In the case of commercial banks, the use of taxpayer funds in an emergency requires the approval of two-thirds majorities of the FDIC and Fed boards, and of the Treasury secretary in consultation with the president.

`Worth the Effort'

``Despite the complexities of designing a resolution regime for securities firms, I believe it is worth the effort,'' Bernanke said today. ``In particular, by setting a high bar for such actions, the adverse effects on market discipline could be minimized.''

Bernanke endorsed several ways for the Fed and other U.S. agencies to gain more oversight of investment banks and financial markets. Congress should legislate ``consolidated supervision'' of investment banks and other big securities firms, with the unspecified regulator having authority over capital, liquidity holdings and risk management, he said.

The Fed itself should also get ``explicit oversight authority'' over payment and settlement systems, putting the Fed on par with counterparts from around the world, Bernanke said.

Congress may consider giving the Fed responsibility for ``promoting the overall stability of financial markets,'' Bernanke said. Still, ``it would be particularly important to make clear that any government intervention to avoid the disorderly liquidation of firms on the verge of bankruptcy should use clearly defined tools and processes,'' he said.

The Fed will play a part in setting capital cushions at securities firms under an agreement yesterday with the SEC designed to dispel concern a failing financial company without central bank oversight could threaten the economy.

The Fed and SEC will collaborate in determining ``guidelines or rules concerning the capital, liquidity and funding'' arrangements of investment banks, the accord said. They will also cooperate in designing ``risk management systems and controls'' for securities firms.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net

Last Updated: July 8, 2008 10:35 EDT

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