Bernanke Says Banks Will Remain Capitalized, but "Too Big to Fail" Needs to End

Federal Reserve Chairman Ben Bernanke stressed the need to overhaul operating rules for "too big to fail" institutions on Tuesday.

Speaking to the Council on Foreign Relations in Washington, D.C., Bernanke said the U.S. government currently remains committed to ensuring major banks have the capital necessary to weather the recession and to meet their commitments.

"Government assistance to avoid the failures of major financial institutions has been necessary to avoid a further serious destabilization of the financial system, and our commitment to avoiding such a failure remains firm," he said.

In a question and answer session following his speech, Bernanke said he thinks bank capital has been very well used and has reduced the deleveraging process.

But going forward, Bernanke said the U.S. government needs to consider creating an authority whose main responsibility is to oversee and prevent systemic risks in the financial structure, and called on Congress to create such a regulatory body.

The idea that some firms are "too big to fail" and will be bailed out by government reduces market discipline, he said, and creates an unlevel playing field for smaller companies.

It has also been proven to be very costly for taxpayers, he said.

Bernanke said current bankruptcy law and framework in the United States is not effective enough when it comes to large non-bank financial firms, and that the range of financial crisis situations that necessitate government intervention should be narrowed.

He said accounting methods need to be adjusted so that they "do not overly magnify the ups and downs in the financial system and the economy."

However, Bernanke said he does not support suspending mark-to-market accounting. He said while it can aggravate market swings, it is a transparent accounting method.

He also said money market mutual funds - as a key source of funding for some businesses - need tighter restrictions, "to increase the resiliency of those funds that are susceptible to runs."

Bernanke said the Fed is a good candidate for his proposed grand systemic risk overseer. "A good case can be made for granting the Federal Reserve explicit oversight authority for systemically important payment and settlement systems," he said. Still, he recognized this responsibility could overburden the central bank.

Overall, the downside of capitalism is that it is prone to booms and busts, Bernanke said, but noted the model helps improve living standards. The central banker also disagreed with the statement that capitalism is "self destructive."

By Megan Ainscow and edited by Stephen Huebl
©CEP News Ltd. 2009