US recovery in 2010 ‘only if’ banks stabilise

US recovery in 2010 ‘only if’ banks stabilise

WASHINGTON: - United States Federal Reserve chairman Ben Bernanke warned yesterday that unless government efforts succeed in restoring financial stability, the nation’s recession may not end this year.
Mr Bernanke told lawmakers that the fast-shrinking US economy is at further risk from a mutually reinforcing cycle of weak growth and financial market strain.

‘To break the adverse feedback loop, it is essential that we continue to complement fiscal stimulus with strong government action to stabilise financial institutions and financial markets,’ he told the Senate Banking Committee.

‘If actions taken by the administration, Congress and the Federal Reserve are successful in restoring some measure of financial stability - and only if that is the case, in my view - there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery,’ he said.

Delivering the Fed’s semi-annual report on monetary policy, he further warned that another risk to the outlook is the global nature of the economic slowdown, which could sap US exports and harm financial conditions to a greater degree than expected.

A slump in US exports as world growth chilled last year added to a deep pullback in consumer spending that steepened the downward slide in the US economy.

Mr Bernanke said the Fed - which has dropped rates to nearly zero - would keep borrowing costs exceptionally low for some time and pledged to use ‘all available tools’ to stimulate the economy and heal financial markets.

He noted that an ongoing Fed programme to buy mortgage finance agency debt and mortgage-backed securities had helped move mortgage rates lower by nearly one percentage point since it was announced in November.

He also said inflationary pressures had receded dramatically as oil and commodity prices had fallen and slack had built up in the economy.

Steps the central bank has taken have helped restore some stability in certain areas of financial markets, the Fed chairman said, citing reduced strains in short-term funding markets, improved commercial paper market conditions and declines in corporate risk spreads.

US President Barack Obama is gambling that he can dispel the cloud of uncertainty that has driven bank shares to a two-decade low by subjecting lenders to a rigorous review and reviving the market for their toxic assets.

Officials will begin the so-called ’stress tests’ of about 20 of the nation’s largest banks today with the aim of ensuring they have sufficient capital to withstand the toughest of economic times. Institutions that cannot privately raise the added capital they need will get taxpayer money.

‘What we need to clean out the system is for investors to know that there are not more crises to come,’ said Mr Raghuram Rajan, a former chief economist at the International Monetary Fund who is now a professor at the University of Chicago.

The administration’s strategy is not without its risks. By shining a light on banks’ potential problems, it may end up fanning investor fears, rather than quelling them.

Policymakers are struggling with that issue as they try to decide how much more help they can provide Citigroup without diluting the value of shares held by investors too much.

Any fresh government funds injected into the banks would be in the form of mandatory convertible preferred shares that would be exchanged into equity only as needed over time.

REUTERS, BLOOMBERG

Source : Straits Times - 25 Feb 2009

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