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.

Fed to lay out interest rate hike plan this week

Federal Reserve Chairman Ben Bernanke is expected to lay out a plan for raising interest rates as the economy picks up steam in the next several months, The Wall Street Journal reported on Monday. The initial focus by the U.S. central bank will be the relatively new interest rate on excess reserves, a tool given to the Fed by Congress in 2008. The interest rate on excess reserves amounts to payments the Fed pays to banks on money left on reserve with it. Currently that rate is 0.25%. The Fed isn't expected to raise any rates for several months.

Fed reduces AIG's debt by $25 billion

AIG announced Tuesday that it completed a deal wiping out $25 billion of its debt to taxpayers by selling stakes in two subsidiaries to the Federal Reserve Bank of New York.

The troubled insurer gave the New York Fed preferred shares of two of its international life insurance companies, including $16 billion of American International Assurance Co. and $9 billion of American Life Insurance Co. The deal was originally announced in March.

The deal brings the New York-based insurer's debt to the New York Fed down to $17 billion. AIG also still owes the U.S. Treasury $44.8 billion from a separate Troubled Asset Relief Program (TARP) loan, so the insurer still owes taxpayers just under $62 billion.

AIG Chief Executive Bob Benmosche said, in a press release, that the debt reduction "sends a clear message to taxpayers: AIG continues to make good on its commitment to pay the American people back."

AIG's (AIG, Fortune 500) stock rose more than 4% on the news in morning trading.

"The agreements further the goals of enabling AIG to fully repay the assistance that it has received from U.S. taxpayers and advancing the company's global restructuring process," the New York Fed said in a statement when the deal was first announced in March.

The Federal Bank of New York initially provided $85 billion worth of support to AIG in September 2008, when the company was on the brink of collapse. AIG's government rescue plan has since been restructured three times, and its total bailout is now worth up to $182 billion.

But much of that bailout has come in the form of government asset purchases that AIG does not need to repay. In addition to the $25 billion announced on Tuesday, the government in March bought up nearly $40 billion of insurance agreements and mortgage-backed securities held by AIG and its business partners.

To pay back the remaining $62 billion it owes the government, AIG will continue to sell off its assets. Despite recording two straight profitable quarters, AIG has said it will not generate enough earnings to repay taxpayers with profits alone.

AIG said Tuesday's transaction will force the company to take a hefty $5.7 billion restructuring charge in the current quarter, which will likely wipe out any profits AIG would have registered in the last three months of 2009.

Despite the government support, the company still faces a steep uphill battle to return to health. Shares of the insurer tumbled 15% Monday, after Bernstein Research analyst Todd Bault told investors that he cut the 12-month price target to $12 a share from $20 because the insurer's "loss reserves are significantly deficient again, much sooner than we would have forecast two years ago."

On Nov. 25, AIG announced that it had resolved its legal dispute with former chairman Maurice "Hank" Greenberg.