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Bernanke says financial sector reforms can't wait for markets to stabilize
(Updates with Q&A) WASHINGTON (Thomson Financial) - As much as they might wish to, neither the Federal Reserve, other regulators nor companies in the financial sector can wait for markets to improve before they begin implementing serious reforms, Fed Chairman Ben Bernanke said today. 'We do not have the luxury of waiting for markets to stabilize before we think about the future,' he said, contrasting a list of immediate financial industry and government changes with the long-term regulatory reform blueprint recently released by the Treasury. Putting in place now the necessary reforms that have already been identified, including improved transparency and risk management, 'could provide important support to the process of normalizing our financial markets,' Bernanke said. He did not discuss current monetary policy or the near-term economic outlook in remarks to the World Affairs Council of Richmond, Virginia. Bernake said that the deleveraging process, where banks are pulling back on lending and raising capital 'is understandable and perhaps desirable' for individual firms but 'has the effect of shrinking available credit' and reducing the banks' role in keeping the economy functioning. Countering that tendency has been the goal of the Fed's interest rate cuts and the various special lending facilities it has established to maintain the flow of credit in the economy. Asked about mark-to-market accounting of securities prices, Bernanke conceded that it 'has been destabilizing' in the current turmoil by forcing down prices in illiquid markets, which forces sales and drives prices down farther in a vicious spiral. 'I don't think we're going back to the old way,' however, he said, as it is important to know what a firm is worth on any given day and changing accounting rules particularly now would likely raise investor suspicion and reduce market confidence even more. US banks remain 'well-capitalized,' he said, and neither they nor the economy are in danger of a decade of stagnation as Japan had in the 1990s. The problem then, he pointed out, was the reverse of mark-to-market. 'Japanese banks had very severe losses because of drops in equity and land prices and were essentially insolvent, but there was a reluctance to admit that or write down the value of the banks.' The government allowed weak banks and other firms to limp along for years before taking action. There is no danger, Bernanke said, of US markets or US regulators letting that happen. Bernanke's speech was a summary of the analysis and recommendations from the President's Working Group (PWG) on capital markets, which is chaired by the Treasury Secretary and includes the Securities and Exchange Commission and Commodity Futures Trading Commission as well as the Fed. The PWG put the blame for the financial market crisis squarely on a breakdown of the so-called originate-to-distribute model of credit extension. Most notably in sub-prime mortgages, brokers who originated or made the original the loans to homebuyers quickly sold them on to other companies for securitization and paid less and less attention to the borrowers' ability to repay. But, Bernake said, the problem went well beyond mortgage lending to include leveraged loans for mergers and buyouts and other types of lending. The credit boom 'was characterized by a general erosion of market discipline, underpricing of risk and insufficient attention by investors to the quality or riskiness of the instruments they purchased.' Bernanke cited other widely criticized aspects of the credit bubble, including overly complex instruments, over-reliance on ratings agencies and poor risk management by investing institutions. 'The originate-to-distribute model thus broke down at a number of key points including at the stages of underwriting, credit rating and investor due diligence,' he said. The pain of market losses will no doubt cause companies to retreat from many of the excesses, Bernanke said, but the PWG is working on tighter regulation of mortgage lending and consumer disclosures, reforms of credit ratings and closer supervision of financial institutions' risk management. [email][email protected][email protected][/email] dem/rw/dem/wash/rw COPYRIGHT Copyright Thomson Financial News Limited 2007. All rights reserved. The copying, republication or redistribution of Thomson Financial News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Financial News.