Bernake Gets It Just Right

As you've read here there is no credit crunch at most banks.

What did occur is that our loosely regulated top "elite banks" -- in an attempt to garner greater and greater returns on their capital -- took on investments that turned out to be simply junk. [toxic assets] In the months since those banks either failed, were bailed out or otherwise exposed to their misguided ways, the government has continued to demonstrate (across both administrations) that it will do everything necessary to remove that junk from those bank balance sheets. It will then return those banks to credibility and further regulate those banks so that they never have the opportunity to swindle us again (in that way at least). Remember for the most part those toxic asset exposures are with the top US banks, not the majority of them.

If the Fed continues its actions as the Chairman indicates it will, that is excellent news for the US economy.

Chairman Ben Bernanke's testimony on Tuesday to the Senate Banking committee further outlines the governments plan to do just that.

Bernanke Describes the Fed Action to Cleanse Top Bank [Elite Bank] Reserves...

The [elite] banks are nervous about lending given their concerns about their own capital positions [more junk?] and about risk aversion and credit issues in the market place. In a way, what the Fed is doing is borrowing by paying interest on reserves to the [elite] banks. That's where we get the money and we're standing in between the [elite] banks and the market place using that money, recycling it into commercial paper, asset-backed securities and other forms of credit. In a way we are becoming the counterparty between the markets and the [elite] banks. When the [elite] banks feel they have opportunities to invest [the junk's all gone], they will. That will begin to create expansion in credit and money supply. That will be the signal for the Fed to begin to pull back. Right now, it's clear [that elite] banks are more willing to hold reserves than they are to make loans.

Bernanke on the Attractiveness of Holding U.S. Treasures...

It seems to be, at least for now, that the dollar and U.S. debt are still very attractive around the world. There is a lot of demand for holding our Treasuries. That being said, we can't go running trillion dollar deficits indefinitely and it's going to be very important as we emerge from the crisis, as we begin to go into recovery stage that we get control of the fiscal situation and begin to bring down the deficit to a sustainable level. For the moment, foreign demand for U.S. securities is strong, but if we don't get control eventually they are going to lose confidence.

The Chairman's Opinion on Inflation/Deflation and Fed Actions Down the Road...

Our view is that over the next couple of years, inflation, if anything is going to be lower than normal, given how much commodity prices have come down, given how much slack there is in the economy. When the economy begins to recover, it's important to raise interest rates and do what is necessary to prevent an overheating that would lead to inflation down the road. We are confident we can do that. Every time we use our balance sheet to try and support the economy, we are thinking about how can we unwind that in a way that would be timely and allow us to take the actions we need to take.

Going Forward Oversight...

I'd like to address the perception that we are putting capital into banks and we are letting them do whatever they want. That it absolutely not the case ... First of all we have regulators (who) are now very actively engaged, particularly with the more troubled [elite] institutions, working with them to restructure, to sell assets, to take whatever steps they need to take to get viable again [junk off their books] and profitable again.

We are not going to let them do what they want. We are going to be very very vigilant to make sure that they are taking the tough decisions that they need to get back to viability.

The major banks all meet current regulatory standards, and well-capitalized is a well-defined regulatory term. The purpose of these assessments that we're going to do going forward is to make sure that banks have enough capital, not only to be well-capitalized in what we expect to be the weak conditions that we will see in the next year, but even under conditions that are weaker than expected. And, moreover, we want to make sure that they have good quality capital and that a sufficient portion of their capital is in common stock and not in other forms of capital. The purpose of these tests is try to assess how much additional capital and what kind of capital they need so they will be able to lend and support the economy even in a situation worse than we currently expect.

We need to be more aggressive in figuring out what the risks are and make sure that we are stress-testing, make sure that we are being conservative in terms of assigning capital to individual kinds of assets. There certainly were some assets that were under-weighted in terms of their risk characteristics when the capital was assigned. We need to look at a variety of other things like off-balance sheet exposures and other things that were not adequately represented

These ongoing actions by the Fed add nothing but great news to our growing list of positives in the short term. The actions are more importantly great news for a sustainable, viable US banking system down the road. And the stock market bounce indicates it believes Bernake is leading those bank revitalization efforts in just the right way.