Bernanke, Kohn Pledge Fed to Withdraw Credit When Crisis Ends

The Federal Reserve’s top two officials assured that they will pull back their emergency- credit programs once the crisis fades, even as they prepare to flood the system further with an excess of $1 trillion.

Chairman Ben S. Bernanke said yesterday in Charlotte, North Carolina that the Fed must retain the flexibility to withdraw its record cash injections to restrain prices. Vice Chairman Donald Kohn said in Wooster, Ohio, “the trick will be unwinding this balance sheet in a timely way to avoid inflation.”

The remarks followed calls by current and former officials for an exit strategy from the central bank’s record accumulation of assets, from corporate debt to mortgage bonds. Concern that political pressure may delay the start of an anti-inflation fight drove the Fed to forge an accord with the Treasury Department last month.

“They have two significant challenges -- one is figuring out when to unwind,” said Christopher Low, chief economist at FTN Financial in New York, referring to U.S. central bankers. The second challenge is how, and that’s made tougher by “so many unwieldy positions. Nothing is as liquid as it used to be” on the Fed’s balance sheet, he said.

The U.S. central bank has effectively printed money to buy or lend against a range of assets to alleviate the credit crunch and revive the economy. Bernanke’s speech yesterday detailed steps that the Fed can take to remove that liquidity, including soaking up cash by the issuance of special bills.

Harder to Sell

The Fed normally raises interest rates by selling Treasuries on its balance sheet, draining reserves from the banking system. That task is tougher with the Fed’s commitment last month to buy more than $1 trillion in mortgage-backed securities, which are harder to sell quickly without roiling markets or potentially attracting political scrutiny.

Bernanke, 55, speaking at a conference hosted by the Richmond Fed bank, hailed last month’s joint statement with the Treasury that spelled out the principles underlying the central bank’s work with the Treasury to revive credit.

While the Fed has implemented “unconventional” measures and taken some “extremely uncomfortable” steps, it’s critical that the efforts “do not interfere with the independent conduct of monetary policy,” Bernanke said.

The joint statement was the culmination of a behind-the- scenes, two-month long debate involving the Fed’s Open Market Committee, as well as the Treasury.

Unemployment Concern

Fueling the debate is the concern that policy makers will have a tough time if they try to end their emergency-lending programs as soon as next year while the unemployment rate, now at quarter-century high 8.5 percent, remains elevated.

A Labor Department report yesterday showed the U.S. lost 663,000 jobs in March, bringing to 5.1 million the drop in payrolls since the start of the recession in December 2007.

The central bank has expanded its balance sheet by $1.2 trillion over the past year, taking on assets including mortgage securities, corporate debt and now long-term Treasuries under the Fed’s latest policy decision last month. The Fed’s total assets stood at $2.08 trillion as of April 1.

The FOMC’s March 18 decision commits the Fed to buy as much as $750 billion of additional mortgage debt, $100 billion of federal agency debt and $300 billion of Treasuries. Separately, the Fed last month began a lending program to restart markets for consumer and business lending. That plan, the Term Asset- Backed Securities Loan Facility, may reach $1 trillion, though the Fed is struggling to persuade investors to participate.

How to ‘Get Out’

“We can’t go into this without knowing how we are going to get out again,” Kohn, 66, who’s worked for the Fed almost four decades, said in response to a question after a speech at the College of Wooster, where he received a bachelor’s degree in economics.

The Fed’s tools for raising short-term rates once the crisis wanes include unwinding the emergency-loan programs, conducting reverse repurchase agreements against long-term securities holdings and increasing the rate the Fed pays on bank reserves, Bernanke said. The emergency facilities were designed to be “unwound as markets and the economy revive,” he said.

Kohn said the Fed and Treasury are seeking “other tools” from Congress to help mop up excess cash. One possibility is that the Fed issue its own securities, or “Fed bills,” or the Treasury could issue special bills, and put the cash on deposit at the Fed.

“It is important to get either of those tools exempt from the debt ceiling so that the Fed could have the power to absorb all the reserves it wanted to,” Kohn said in response to a question.

Bernanke said that “the large volume of reserve balances outstanding must be monitored carefully, as -- if not carefully managed -- they could complicate the Fed’s task of raising short-term interest rates when the economy begins to recover or if inflation expectations were to begin to move higher.”