Geithner Says Markets Still `Impaired,' Urges Action (Update5)

By Craig Torres


April 3 (Bloomberg) -- New York Federal Reserve Bank President Timothy Geithner said capital markets are still ``substantially impaired'' and policy makers and financial industry leaders must ``act forcefully'' to stem the crisis.

``What we were observing in U.S. and global financial markets was similar to the classic pattern in financial crises,'' Geithner said in testimony to the Senate Banking Committee. He cited ``a self-reinforcing downward spiral'' of asset sales, ``higher volatility, and still lower prices.''

The New York Fed chief also said that the central bank's emergency actions to rescue Bear Stearns Cos. were aimed at halting a crisis that would have caused ``protracted'' damage to the economy. Fed Chairman Ben S. Bernanke told lawmakers that while the aid wasn't a Fed bailout of Bear Stearns, it was true that the central bank ``bailed out the markets in general.''

Fed officials are trying to defend the aid to Bear Stearns as an emergency move to avert deeper damage to the U.S. financial system. Lawmakers are scrutinizing the deal, concerned that government funds may be at risk and that regulators failed to recognize the mounting crisis.

Securities and Exchange Commission Chairman Christopher Cox defended his agency's performance during the Bear Stearns collapse, telling lawmakers that the SEC succeeded in protecting consumers. Bear's brokerage clients were ``fully protected,'' achieving the SEC's mandate, he said at the hearing.

`Very Fast'

Fed officials have noted that the SEC is the prime regulator of investment banks. Asked whether supervisors should have known about Bear's deteriorating conditions, Geithner said ``it's hard to know,'' given that collapses ``can happen very fast.''

Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, said the SEC was ``seemingly unaware'' of Bear Stearns's plight.

Bear Stearns Cos. Chief Executive Officer Alan Schwartz told the committee that the fifth-largest U.S. securities firm may have survived if the Fed had acted sooner to lend money directly to investment banks. ``It is highly, highly unlikely in my personal opinion that we would be in the situation we find ourselves in today'' had the Fed opened the window earlier, Schwartz said.

Bear Stearns tried to confront rumors about the firm's viability, which may have been intended to ``induce panic,'' Schwartz said. He added that it would be ``appropriate'' to probe the source of the rumors, and that the Fed's discount window may help prevent future bank runs.

Geithner's 22-page testimony included a narrative on the events that led to the Fed's emergency loan for Bear Stearns, and the economic consequences if the central bank hadn't stepped in.

`Low-End Price'

``Absent a forceful policy response, the consequences would be lower incomes for working families, higher borrowing costs for housing, education and the expenses of everyday life, lower value of retirement savings, and rising unemployment,'' said Geithner, who was lead negotiator during the decision to finance $30 billion of illiquid Bear securities in the takeover by JPMorgan Chase & Co., the first transaction of its kind.

JPMorgan Chief Executive Officer Jamie Dimon said his firm was the only one ``in a position to help,'' and that it ``kept the riskier and more-complex securities in the Bear Stearns portfolio for our own account.''

Treasury officials, who conferred with Fed counterparts, recommended a ``low-end'' price for the Bear acquisition, Treasury Undersecretary Robert Steel said at the hearing.

``There was a view that the price should not be very high, or should be towards the low end'' because of the government's involvement and risk of moral hazard, or protecting those who took on risk, Steel said.

The New York Fed presented a one-page description of the portfolio. The assets include investment-grade securities and residential and commercial mortgage loans, all of which were current on principal and interest as of March 14. The staff of some lawmakers will be able to review the full list on a confidential basis, the statement said.

Fed's Impact

The portfolio also holds collateralized mortgage obligations, most of which are bonds of government-sponsored agencies such as Freddie Mac and Fannie Mae. The holdings include asset-backed securities, adjustable-rate mortgages, commercial mortgage-backed securities and collateralized mortgage obligations issued by companies other than the agencies.

Geithner, vice chairman of the Fed's interest-rate setting Open Market Committee, said the central bank's actions to date ``have helped avert substantial damage to the economy, and they have brought a measure of tentative calm to global financial markets.''

``Policy makers and financial market participants need to continue to act forcefully,'' and ``their actions need to be proportionate to the challenges,'' Geithner said.

``The Federal Reserve System's response has helped reduce the risk of systemic damage to the financial system and thereby helped mitigate a potential source of downside risk to growth,'' he added.

Money Markets

The current financial crisis is the worst since the Great Depression, billionaire George Soros said in an interview yesterday. ``This will probably not prove to be the final bottom'' in financial markets, he said. He added that the Fed's ability to help by lowering interest rates further may be limited given a falling dollar.

Geithner, 46, has advised the board on several efforts by the Fed that increased credit to financial institutions in the past seven months.

The New York Fed administers the System Open Market Account, which is involved in money markets on an almost daily basis to set the federal funds rate, the main policy rate, which now stands at 2.25 percent. Officials have cut the rate 3 percentage points since September.

The New York Fed manages the Primary Dealer Credit Facility, an overnight-loan mechanism set up for government bond dealers after the Bear Stearns rescue, and the Term Securities Lending Facility, which allows bond dealers to swap their mortgage securities for the Fed's holdings of Treasury notes for 28 days.

In a question-and-answer period, Bernanke said the primary dealer facility was put in place March 16 to prevent a run on other brokers, and said it would have to be closed once the emergency conditions in markets subsided.

Monitoring Banks

The New York Fed has examiners at the ``major investment banks'' so the central bank has the ``direct capacity to assess the financial condition of these institutions,'' Geithner said.

Geithner also presented lawmakers with an outline for overhauling the regulation of financial markets and banks, which spans more than a half-dozen agencies.

His recommendations included a consolidation of regulators, a ``stronger set of shock absorbers'' in the form of more capital and back-stop financing at large financial institutions, and broader authority by the Fed to respond to ``systemic'' instability, including emergency lending.

Geithner took the helm of the New York Fed in 2003, and previously worked as a Treasury undersecretary in the Clinton administration, when he helped coordinate the U.S. response to the Asian financial crisis.