[NOTE: This is a news briefing of a March 10, 2009, meeting at the Council on Foreign Relations. Full transcript of Bernanke's speech available here.]
WASHINGTON -- Federal Reserve Chairman Ben S. Bernanke has urged an overhaul of U.S. financial regulation aimed at smoothing out cyclical booms and busts in financial markets, signaling that the process of broadening government controls might translate to added oversight authority for the Fed.
Speaking at the Council on Foreign Relations in Washington on March 10, Bernanke traced the current global economic crisis to extraordinary global imbalances in trade and capital flows that began in the late 1990s. The United States and other leading industrial states over a decade-long period received large capital inflows from emerging market states but "failed to ensure that the inrush of capital was prudently invested," Bernanke said, "a failure that has led to a powerful reversal in investor sentiment and a seizing up of credit markets."
To confront the immediate crisis, the Fed chairman asserted that his agency and the Obama administration were acting appropriately to contain the damage to the financial system. For example, he has reduced the benchmark interest rate to as low as zero while Obama won passage of a $787 billion stimulus plan last month. Other efforts include shoring up oversight of risk management, strengthening what Bernanke called "systemically critical firms" to improve liquidity, and making sure large banks have adequate capital.
Later, in response to a question, Bernanke said if government efforts to stabilize banks are successful then "there is a good chance the recession will end later this year, and that 2010 will be a period of growth."
But Bernanke said going forward there will be a need for improving the country's financial infrastructure as well as creating a new regulatory authority responsible for ensuring financial stability. Referring to the outsized role of some huge financial firms in destabilizing the economy, Bernanke called on policymakers to "address this issue by better supervising systemically critical firms to prevent excessive risk-taking and by strengthening the resilience of the financial system to minimize the consequences when a large firm must be unwound."
Among the firms deemed "too big to fail" in the current crisis are Citigroup, which has already received three U.S. government bailouts, and American International Group, whose rescue package was recently revised to roughly $170 billion.
Rep. Barney Frank (D-MA), chairman of the House Financial Services Committee, has voiced support for the Fed taking on responsibility for overseeing "systemic risk," although Senate Banking Committee Chairman Christopher Dodd (D-CT) has expressed doubts.
Bernanke indicated the need for the Fed to play a greater role in oversight of the financial system. "A good case can be made for granting the Federal Reserve explicit oversight authority for systemically important payment and settlement systems" in financial markets, he said. This would be an improvement on what he termed the current "patchwork of authorities" for these systems.
He also urged a review of accounting rules so they do not "overly magnify the ups and downs in the financial system and the economy." These so-called mark-to-market rules govern how firms value assets and have become an issue at a time when the markets for banks' huge mortgage-backed securities and illiquid assets have become frozen and valuation has become difficult. A House subcommittee is due to hold a hearing on mark-to-market rules later this week.
Asked following his speech about the Group of 20 summit scheduled for early next month in London, Bernanke said it was unlikely a detailed recovery plan would emerge. But he said the assembled leaders could agree on principles for international coordination on any reforms to the regulatory regime for financial markets.
"We have banks and insurance companies with subsidiaries in 100 countries, or 120 countries, and there are so many jurisdictions that dealing with problems among those companies is extraordinarily complicated, and in order to do that successfully we need to have agreements, conventions that will help us to cross jurisdictions in an effective and cooperative way," he said.