Chairman Ben S.

Bernanke
Developments in the financial markets
Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate

April 3, 2008

Chairman Dodd, Senator Shelby, and other members of the Committee, I appreciate this opportunity to discuss current
economic and financial conditions and the actions the Federal Reserve has taken to stabilize financial markets and the
economy.

Although the situation has recently improved somewhat, financial markets remain under considerable stress. Pressures
in short-term bank funding markets, which had abated somewhat beginning late last year, have increased once again.
Many lenders have been reluctant to provide credit to counterparties, especially leveraged investors, and increased the
amount of collateral they required to back short-term security financing agreements. To meet those demands, investors
have reduced their leverage and liquidated holdings of securities, putting further downward pressure on security prices.
Credit availability has also been restricted because some large financial institutions, including some commercial and
investment banks and the government-sponsored enterprises (GSEs), have reported substantial losses and write-downs,
reducing their capital available to support increased lending. Some key securitization markets, including those for
nonconforming mortgages (Jumbo Loans), continue to function poorly if at all. (Due to Fannie May & Freddie Mac
not supporting loans at amounts over national mortgage averages of approx. $300-$400k of which is insufficient
for CA. & FL. Where the brunt of the sub-prime mortgages are defaulting).

1. These developments in financial markets--which themselves reflect, in part, greater concerns about housing and
the economic outlook more generally--have weighed on real economic activity.
2. Notably, in the housing market, sales of both new and existing homes have generally continued weak, partly as
a result of the reduced availability of mortgage credit, and home prices have continued to fall.
3. Private payroll employment fell substantially in February, after two months of smaller job losses, with job cuts
in construction and closely related industries accounting for a significant share of the decline.
4. But the demand for labor has also moderated recently in other industries.
5. Overall, the near-term economic outlook has weakened relative to the projections released by the Federal Open
Market Committee (FOMC) at the end of January.
6. Inflation has also been a source of concern (Food & Fuel are de-leveraging and the ‘fear factor’ of Gold is
coming down daily. Hedge funds unwinding positions in commodoties as a hedge created yet another bubble in
the last 24 months which is de-leveraging as assets need to be sold to cover ‘margin calls’ of sorts for huge
30.40 to 1 leveraged sub-prime derivative ‘bets’).
7. We expect inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation
developments carefully.

• Well-functioning financial markets are essential for the efficacy of monetary policy and, indeed, for
economic growth and stability.
• Consistent with its role as the nation's central bank, the Federal Reserve has taken a number of steps in
recent weeks to improve market liquidity and market functioning.
• These actions include reducing the cost and increasing the allowable term of discount window credit to
commercial banks;
• increasing the size of our Term Auction Facility, (See portfolio.com article below) through which
credit is auctioned to depository institutions;
 • initiating a Term Securities Lending Facility, which allows primary dealers to swap less-liquid mortgage
backed securities for more-liquid Treasury securities;
• and creating the Primary Dealer Credit Facility, which is similar to the discount window but accessible
to primary dealers.
• Although these facilities operate through depository institutions and primary dealers, they are designed
to support the broader financial markets and the economy by facilitating the provision of liquidity by
those institutions to their customers and counterparties.
• With respect to monetary policy, at its March meeting the FOMC reduced its target for the federal funds
rate by 75 basis points to 2-1/4 percent.

It was in this context of intensifying financial strains that, on March 13, Bear Stearns advised the Federal Reserve and
other government agencies that its liquidity position had significantly deteriorated and that it would have to file for
bankruptcy the next day unless alternative sources of funds became available.

1. This news raised difficult questions of public policy. Normally, the market sorts out which companies survive
and which fail, and that is as it should be. However, the issues raised here extended well beyond the fate of one
company.
2. Our financial system is extremely complex and interconnected, and Bear Stearns participated extensively in a
range of critical markets. (To the tune of $10 trillion).
3. The sudden failure of Bear Stearns likely would have led to a chaotic unwinding of positions in those markets
and could have severely shaken confidence. (READ:Massive bank runs once confidence was shaken that if
it could ‘happen to Bear – it could happen to ANYONE (any and ALL other Banks).
4. The company's failure could also have cast doubt on the financial positions of some of Bear Stearns' thousands
of counterparties and perhaps of companies with similar businesses.
5. Given the exceptional pressures on the global economy and financial system, the damage caused by a default by
Bear Stearns could have been severe and extremely difficult to contain.
6. Moreover, the adverse impact of a default would not have been confined to the financial system but would have
been felt broadly in the real economy through its effects on asset values and credit availability.
• To prevent a disorderly failure of Bear Stearns and the unpredictable but likely severe consequences for
market functioning and the broader economy, the Federal Reserve, in close consultation with the
Treasury Department, agreed to provide funding to Bear Stearns through JPMorgan Chase.
• Over the following weekend, JPMorgan Chase agreed to purchase Bear Stearns and assumed Bear's
financial obligations.

The purpose of our action, as with our other recent actions--including our provision of liquidity to financial firms and
our reductions in the federal funds rate target--was, as best as possible, to improve the functioning of financial markets
and to limit any adverse effects of financial turmoil on the broader economy.

We will remain focused on those objectives.

Clearly, the U.S. economy is going through a very difficult period. But among the great strengths of our economy is its
ability to adapt and to respond to diverse challenges. Much necessary economic and financial adjustment has already
taken place, and monetary and fiscal policies are in train that should support a return to growth in the second half of
this year and next year. I remain confident in our economy's long-term prospects.

Thank you. I would be pleased to take your questions.

Return to top
 6153377850875191

WELCOME TO CONDÉ NAST PORTFOLIO - NEWSLETTER RSS MOBILE HELP

SEARCH

Subscribe for just $1 an issue

In This Issue of Condé Nast Portfolio

Market Movers
by Felix Salmon

Main
Sovereign Wealth Funds: Still Big Ben Stein Watch, Expelled Edition
Apr 3 2008 4:43PM EDT

Are Investment Banks Really Trying to Fix the Auction-Rate Market?

The WSJ reports on the market in auction-rate securities today:

Last week, UBS said it was marking down an undisclosed amount of the value of auction-rate securities held by its
customers. Other banks, including Merrill, aren't marking down their values. In both cases, banks are scrambling
furiously to fix the frozen market.

Um, scrambling furiously? As far as I can tell, they're doing Absolutely Nothing. There's certainly no evidence in the
article of any concrete actions the banks are taking to fix this problem.
Indeed, the whole problem with this market is that the banks stopped scrambling furiously to provide a bid in every
auction which came along. So long as the banks made a market in these securities, everything worked fine. Then they
stopped making a market, and the market, predictably enough, froze up.

Quite clearly the investment banks here were the proximate cause of the problem. The WSJ is being far too polite in
suggesting that in fact they're frantically working towards a solution.

See more in

• banking
• bonds and loans

2 Comments

Add Your Comment

Please enter a display name and email address to add a comment.
Required fields are marked with an asterisk (*)
Comments*

0/2000
Display Name *

This will be displayed next to your comment.

Email Address *

Enter the text you see in the image *

Try a New One

This helps us prevent automated registrations and spamming.
Send me updates on new Portfolio.com offerings and products.
Remember me
Selecting "Remember me" allows you to make comments on the site for 30 days without having to enter your name and
email address each time. Your information will be saved only for this period and will not be shared. I agree that
submitting a comment constitutes acceptance of the User Agreement and Privacy Policy.

Oldest First Newest First Show me only Recommended Comments

Posted: Apr 03 2008 5:31pm ET
As long as you have $10M, no problema.

High Net Worth Takes On New Meaning in Auction Mess: Joe Mysak
April 1 (Bloomberg) -- If you have less than $10 million to invest, you can go dangle. That seems to be what securities
firms are telling clients.....I suspect the real reason the securities firms gave this answer was to marginalize an entire
group of investors they now find expendable. In fact, this group's real sin is that they aren't wealthy enough for Wall
Street securities firms to care about them.
By maynardGkeynes
Report Abuse

Posted: Apr 03 2008 7:59pm ET

Spot on Felix! I would also say the issuers are dragging their feet. They are desperately trying not to kill the golden
goose by de-leveraging these POS investments.
By Lowell

<a

The Auction-Rate Lockout

BY SUSANNE CRAIG, DIYA GULLAPALLI AND LIZ RAPPAPORT
Word Count: 914 | Companies Featured in This Article: Merrill Lynch,
UBS, Citigroup, Morgan Stanley, Goldman Sachs Group

When John Carney, a 68-year-old New York attorney, received his Merrill
Lynch & Co. brokerage statement this month, it showed he held $550,000
in short-term securities safely at their full value.

Tracey Young, a 53-year-old mother of two who helps manage family

funds through a UBS AG account, got a different assessment. The $3
million in short-term securities she held had been marked down by
$170,000. "I am in a panic," she says.

Behind this tale of two statements is a big dilemma on Wall Street. Many
firms like Merrill Lynch and UBS have placed their customers in short-
term investments ...

'Auction Rates' Clip Tech Firms' Profits

BY REBECCA BUCKMAN
Word Count: 951 | Companies Featured in This Article: MetroPCS
Communications, Palm, EarthLink, Monster Worldwide, Intuit

Technology firms, which traditionally shunned debt and were thought to be

relatively immune to a credit crunch, are seeing their earnings dented by
holdings of auction-rate securities.

Dallas telecom company MetroPCS Communications Inc. recently took an

$83 million charge related to auction-rate securities, the arcane debt
instruments -- once thought to be as safe as cash -- that are now nearly
impossible to sell in today's jittery markets. Last Thursday, hand-held-
device maker Palm Inc. said it, too, would take a charge for auction-rate
holdings, though it hasn't disclosed how much.

Other tech companies, including Internet-service provider EarthLink Inc.,

said in

<a
RELATED ARTICLES FROM ACROSS THE WEB
Related Content may require a subscription | Subscribe Now -- Get 2 Weeks FREE
Related Articles from WSJ.com
• Massachusetts Probes Failed Auctions Mar. 28, 2008
• 'Auction Rates' Clip Tech Firms' Profits Mar. 28, 2008
• Lawyer Pleas in Case Charging that He Bilked Firm and Clients
Mar. 28, 2008
• Lawyer at Major Firm Charged with Bilking Firm and Clients
Mar. 28, 2008
Related Web News
• 3 Firms Are Asked for Data on Auction-Rate Shares Mar. 29, 2008
nytimes.com
• Mass. regulator subpoenas UBS, Merrill, BofA Mar. 28, 2008 boston.com
• UBS Marking Down Value Of Auction-rate Securities: Report
Mar. 28, 2008 msn.foxsports.com
• UBS Gives Haircuts Mar. 28, 2008 forbes.com

Recommended by 1 Users
Report Abuse

Recent Blog Posts

• Extra Credit, Friday Edition

• Apr 4 2008 12:12AM EDT
• Ben Stein Watch, Expelled Edition
• Apr 3 2008 11:29PM EDT
• Are Investment Banks Really Trying to Fix the Auction-Rate Market?
• Apr 3 2008 4:43PM EDT
• Sovereign Wealth Funds: Still Big
• Apr 3 2008 4:18PM EDT
• Silly Idea of the Day: Opening Foreign Brokerage Accounts
• Apr 3 2008 3:12PM EDT
• Why Silicon Valley Need Not Worry About Increased Regulation
• Apr 3 2008 2:18PM EDT
• How the Housing Bill Could Help New York City
• Apr 3 2008 11:53AM EDT
• Geithner Explains the Bear Stearns Rescue
• Apr 3 2008 11:15AM EDT
• Why Sovereign Wealth Funds Should Invest in Africa
• Apr 3 2008 10:20AM EDT
• Buying Bonds in the Expectation of Technical Default
• Apr 3 2008 9:36AM EDT
• Extra Credit, Thursday Edition
• Apr 3 2008 12:00AM EDT
• The Capital Infusion League Table
• Apr 2 2008 8:26PM EDT
• Should the Fed Buy Securities Outright?
• Apr 2 2008 7:10PM EDT
• Bill Ackman's Brutal Target Losses
• Apr 2 2008 3:17PM EDT
• Meme of the Week: Food Stamps
• Apr 2 2008 12:57PM EDT

Related News

• Morgan Stanley 1Q Profit Tops Estimates AP

• Sector Glance: Investment Banks AP
• Merrill riskiest after Bear Stearns, says Wachovia Reuters
• Out of the Gate: Investment Banks AP
• Sector Snap: Investment Banks Fall AP