Bernanke lays out plan for tighter money

Federal Reserve Chairman Ben Bernanke unveiled a blueprint Wednesday for pulling back the trillions of dollars the central bank has provided to prop up the nation's economy.

"These programs, which imposed no cost on the taxpayer, were a critical part of the government's efforts to stabilize the financial system and restart the flow of credit," Bernanke said in prepared testimony for a Capitol Hill hearing that was postponed due to snow. "As financial conditions have improved, the Federal Reserve has substantially phased out these lending programs."

But Bernanke also emphasized that the U.S. economy still needs the support of easy money policies. He said that "at some point" in the future the Fed will "need to tighten financial conditions" by raising short-term interest rates and reversing programs that pumped liquidity into the markets.

The markets have been waiting to hear an inkling of how the Fed plans to start raising rates and pulling back on the trillions the Fed has pumped into the financial system since it started teetering on the edge of collapse back in late 2008.

For the last 18 months, the Fed has bought mortgages, long-term Treasurys and the debt of mortgage finance firms Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500).

Currently, the Fed holds $2.29 trillion on its balance sheets, up from $934 billion in September 2008, when the financial crisis really kicked into gear.

On Wednesday, Bernanke laid out a plan to sell some of those mortgages, Treasurys and debt, by offering what's called reverse repurchasing agreements. Under those agreements, the Fed sells its securities to a third party while agreeing to rebuy them at some point in the future.

The second way the Fed plans to soak up money is to sell banks and financial firms the equivalent of certificates of deposit. In this case, the Fed gets a chunk of the bank's reserves in exchange for paying interest at a steady rate. Dubbed a "term deposit facility," these deposits would be auctioned off and banks couldn't count their investment in the Fed as cash or reserves.

"Reverse repos and the deposit facility would together allow the Federal Reserve to drain hundreds of billions of dollars of reserves from the banking system quite quickly, should it choose to do so," Bernanke said.

Bernanke said he planned to start testing out such programs this spring.

But he added that the "firming" of exit strategy policy would start with an increase in the interest rate paid on reserves, adding that the Fed could always take a more "rapid exit," by increasing the rate paid on reserves if the economy needed it.

Bernanke was supposed to testify before the House Financial Services Committee about unwinding emergency Fed liquidity programs. The hearing fell victim to the snow that has blanketed the nation's capital over the past five days, and has yet to be rescheduled. Instead, the Fed released Bernanke's statement.

Two weeks ago, the Fed left interest rates unchanged at near zero percent, pointing to improvement in business spending but adding the recovery is likely to be "moderate" for some time.

But one member, Kansas City Fed President Thomas Hoenig, voted against the Fed's latest action, saying he thought economic conditions had improved enough so that low rates were "no longer warranted." He was the first dissenting vote among Fed policymakers since January 2009.

Did Bernanke Bully BOA?

A new report by the New York Attorney General says that government officials bullied Bank of America Chief Ken Lewis into accepting a merger with Merrill Lynch--then ordered him to keep mum about losses at Merrill.

What's at stake? The integrity of the government's bailout actions, for one. Federal Reserve Chairman Ben Bernanke's reputation, for another. And of course Lewis' job.

Thursday, New York Attorney General Andrew Cuomo released documents charging that in December former Treasury Secretary Henry Paulson pressured Lewis into accepting the merger or risk a management shake-up at Bank of America. Lewis was hesitant about the merger because Merrill's projected fourth-quarter losses had jumped from $9 billion to $12 billion in just one week. They eventually topped $15 billion.

Equally as important, Lewis didn't make Paulson's threat public, nor did he tell Merrill Lynch or warn shareholders about the staggering losses. According to a letter to lawmakers and regulators, Paulson and Bernanke told him to keep mum.

"I was instructed that 'We do not want a public disclosure,'" the letter quotes Lewis as saying.

Federal Reserve officials didn't return a request for comment. Neither did a spokesperson for Paulson, who has taken up residence at Johns Hopkins University's School for Advanced International Studies. Don't be surprised if both men are soon called before Congress to testify about their actions.

It's not yet clear if any of this behavior was illegal. Paulson is out of government now, so his role going forward is limited. But the news could seriously damage Bernanke's credibility if he's seen as prodding a bank to accept a questionable merger and urging bank officials not to disclose important information about it. The Fed chief has developed a reputation as someone who's brought more transparency to the inner workings of the Fed. Recently he even appeared on the news program 60 Minutes to explain the government's response to the financial crisis.

Finally, there's the fate of Lewis to consider, and some are already using the report by Cuomo's office, first reported by The Wall Street Journal, to call for the Bank of America boss' head. The Change to Win Investment Group, which works with union-sponsored pension funds, is urging shareholders to vote out Lewis and several board members at Bank of America's annual meeting April 29.

The news "underscores why Bank of America needs a CEO and board of directors that will put the interests of shareholders ahead of their own interest in self-preservation," the group said in a statement.

Bernanke: I Wanted to Sue AIG to Halt Bonus Payments

Federal Reserve Chairman Ben Bernanke told Congress Tuesday that he tried to prevent American International Group from paying out lavish bonuses, and even asked that the company be sued to halt the payments, but was advised against it.

Bernanke told lawmakers at a tense House Financial Services Committee hearing that he found it "highly inappropriate" for the bailed-out insurer to pay $165 million in bonuses to the very division that was "the primary source of AIG's collapse."

He said he was told the payments could not be stopped because of contractual obligations -- but he was also warned that legal action, which he wanted to pursue, could end up awarding the same employees more money in punitive damages.

"I then asked that suit be filed to prevent the payments," Bernanke said. "Legal staff counseled against this action on the grounds that Connecticut law provides for substantial punitive damages if the suit would fail. Legal action does have the perverse effect of doubling or tripling the financial benefits to the (employees)."

Treasury Secretary Timothy Geithner, appearing with Bernanke, also asked Congress for broad new powers Tuesday to regulate nonbank financial companies like the troubled insurer, whose collapse could jeopardize the economy.

"AIG highlights broad failures of our financial system," Geithner said. "We must ensure that our country never faces this situation again."

Geithner acknowledged that the current climate of anger, including the furor over those retention bonuses, will complicate any effort by the Obama administration to get more bailout money from Congress. "We recognize it will be extraordinarily difficult," he said.

AIG has become a symbol of reckless risk-taking on Wall Street. The House last week voted overwhelmingly to slap 90 percent taxes on the largest bonuses and similar, although not as punitive, legislation is before the Senate.The bonuses came even as AIG reported a stunning $62 billion loss, the biggest in U.S. corporate history.

The government has bailed out AIG four times, to the tune of more than $180 billion altogether.
New York Attorney General Andrew Cuomo said Monday that 15 employees who received some of the largest bonuses from AIG have agreed to return them in full, totaling about $50 million.