Bernanke: Credit Crisis Isn't Over Yet

In a televised speech, the Fed chairman cites ongoing financial market troubles and says Wall Street needs to address the fundamental sources of strain.
By Nat Worden ,

Federal Reserve Chairman Ben Bernanke said Tuesday that credit market conditions have improved, but "at this stage conditions in financial markets are still far from normal."

In a televised speech to the Atlanta Fed's annual conference in Sea Island, Ga., Bernanke said that financial institutions must address the "fundamental sources of financial strains" in Wall Street's credit crisis through a process of deleveraging, raising new capital and improving risk management.

That said, he noted that credit spreads in key markets have narrowed in a sign that confidence has returned after the depths of the crisis in mid-March when the Fed orchestrated the fire sale of

Bear Stearns

( BSC), the nation's fifth-largest investment bank, to

JPMorgan Chase

(JPM) - Get Report

to avoid a bankruptcy that threatened a systemic financial meltdown.

"To date, our liquidity measures appear to have contributed to some improvement in financing markets," said Bernanke, adding that "once financial conditions become more normal, the extraordinary provision of liquidity by the Federal Reserve will no longer be needed."

Bernanke didn't send any signals about the direction of policy for the central bank's open market operations, which set the federal funds rate target -- a key, short-term interest rate for interbank lending that reflects changes in the money supply. Currently, fed funds futures show that the market expects the Fed to keep its rate target steady at 2% at its June meeting.

The Fed has slashed its fed funds target by 325 basis points since the outbreak of the credit crisis last summer. Its actions have been the subject of intense controversy as the economy has continued to show signs of a slowdown amid rising signs of inflation, especially in food and energy prices. Crude oil futures prices have rocketed up above $125 a barrel, sending gasoline prices soaring, and the value of the dollar has plunged.

Meanwhile, Bernanke did say the Fed stands ready to expand to increase the size of the Fed's term auction facility if needed. The TAF has already been tripled since the extraordinary liquidity provision was set up in late 2007.

In addition, the Fed has recently expanded the use of its so-called discount window to provide emergency liquidity to investment banks, like

Citigroup

(C) - Get Report

,

Bank of America

(BAC) - Get Report

and

Lehman Brothers

( LEH). It has lent out Treasury securities to financial institutions against illiquid collateral, like mortgage-backed securities, through a separate Term Securities Lending Facility.

Those measures appear to have calmed financial markets to some degree, and Bernanke's speech on Tuesday was largely an explanation of the Fed's actions, which have raised questions in the market about moral hazard since the U.S. taxpayer could ultimately be on the hook for the risks it has undertaken on behalf of the financial industry.

Bernanke said the Fed can provide liquidity to financial institutions in times of crisis in order to head off a panic by investors. He did not address the controversy over what new regulatory frameworks may be appropriate in light of the Fed's recent expansion of its role in the market.

He did stress that the crisis still lingers, noting that "strong participation" at recent TAF auctions even after the recent expansions in auction sizes reflect the persistence of funding pressures on financial institutions. He also said depository institutions have borrowed "significant amounts" under the primary credit program for terms of up to 90 days.

"A number of securitization markets remain moribund," said Bernanke. "Risk spreads -- although off their recent peaks -- generally remain quite elevated, and pressures in short-term funding markets persist."

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