Bernanke Takes Little Risk

If actions taken by the administration, the 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.”

These were the words of Fed Chairman Ben Bernanke, testifying before the Senate Banking Committee. It seems to us that Bernanke was master of the obvious in his semi-annual testimony, although his tone was the most somber we have observed of him in the last few years of these speeches. Considering that the financial sector is at the heart of much of the economy’s woes right now, it seems rather obvious that if this sector regains some normalcy, then the broader economy would start to recover. Perhaps he has become less fond of sticking his neck out as the global financial crisis grinds on; early on in the crisis, the Chairman was less reticent when it came to talking bluntly about the situation.

More importantly, Bernanke did signal that the Fed would continue to use all resources at its disposal to revive the financial system. This means that interest rates should stay “exceptionally low for some time,” especially as worries about inflation have cooled considerably. He also alluded to the fact that banks could require an additional round of capital injections in order to insure solvency. The extend to which certain banks need capital will be determined by a series of stress tests that regulators will impose on banks to see how they would hold up under more difficulty in the coming months.

On-going rumors of bank nationalization were a major reason for the sell-off in stocks on Monday because if the government were to convert to common its $45 billion in preferred stock in Citi (C) then it would have a majority interest in the bank, effectively nationalizing it. Nationalization is a very risky proposition for many reasons, including the fact that taxpayer money would have much greater exposure to losses as banks continue to write down assets. Furthermore, the government would gain voting rights for its shares, which opens a whole new can of worms. Clearly regulators are walking a fine line regarding bank nationalization and Mr. Bernanke declined to address the rampant speculation in his prepared remarks. However, the White House’s official policy remains that “privately held banks are the way to go.”

There were few surprises from Bernanke as he basically just reiterated what we already know: banks are key to recovery, the housing sector is extremely weak and the Fed will continue to do all in its power to revive the economy. Although there are no blockbuster headlines, surprisingly the market seemed to take comfort in hearing the Fed Chief say, once again, that he is doing his best. So far this has been woefully inadequate; somebody wake Larry Summers up when 2010 rolls around.

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