Large US investment banks will be able to access emergency cash from the Federal Reserve into next year if market turmoil persists

The Fed going way out of bounds. What about moral hazard and banks with this emergency cash? Comments? Posted by Corey Curwick of Project Liberty Article Link from FT.com: Feds ready to extend bank aid 

Fed ready to extend bank aid

By James Politi in Washington

Published: July 8 2008 13:53 | Last updated: July 8 2008 22:43

Large US investment banks will be able to access emergency cash from the Federal Reserve into next year if market turmoil persists, Ben Bernanke said on Tuesday in a sign of the growing concern among policymakers that financial strains could continue for some time.

The signal from Mr Bernanke is likely to soothe Wall Street, in that it confirms Fed support for investment banks through the credit crisis. US stocks rose on Tuesday, the dollar rallied against the euro and oil prices staged their biggest retreat in months.
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As well as signalling fears that the effects of market turmoil may be felt for longer than hoped, extending the credit facility would press Congress to tighten regulation of investment banks.

Speaking in Virginia at a forum on mortgage lending for low-income households, Mr Bernanke said: “We are currently monitoring developments in financial markets closely and considering several options, including extending the duration of our facilities for primary dealers beyond year-end, should the current and exigent circumstances continue to prevail in dealer-funding markets.”

In March, the Fed granted primary dealers – a term that covers investment banks such as Lehman Brothers and Merrill Lynch – access to emergency cash for at least six months in an effort to stabilise the US financial system on the same day it helped rescue Bear Stearns with a $29bn loan.

Previously, access to emergency funding was only allowed for commercial banks such as Citigroup and JPMorgan.

Although the moves helped stabilise credit markets for several months, worries about mortgage debt and the health of financial institutions have flared up again.

More evidence of the depth of the US housing crisis came yesterday when a measure of pending home sales fell at an unexpectedly steep rate of 4.7 per cent in May.

The regulator of Fannie Mae and Freddie Mac sought to ease investors’ fears that the two government-sponsored mortgage financiers might have to raise billions of dollars of capital in response to potential accounting changes. James Lockhart, director of the Office of Federal Housing and Enterprise Oversight, told CNBC that “an accounting change should not drive a capital change.”

Worries that Fannie and Freddie would have to raise more capital sent their shares plunging 16.2 per cent and 17.9 per cent, respectively, on Monday. However, their share prices were up 11.94 per cent and 13.01 per cent, respectively, on Tuesday.

Mr Bernanke’s comments came as Congress was preparing to examine what kind of changes to financial regulation should be made in the wake of the credit crisis. The House financial services committee will on Thursday hold its first hearing on the topic, with testimony expected from Mr Bernanke and Hank Paulson, Treasury secretary.

In his speech on Tuesday, Mr Bernanke said Congress “may wish to consider” whether new tools were needed to liquidate a “systemically important” investment bank on the verge of bankruptcy, as with Bear Stearns.

The Fed chairman said Treasury should take a lead in this process and that one option was a structure allowing federal regulators to set up a “bridge bank” to help a securities firm – a strategy used for failing commercial banks.

“A bridge bank authority is an important mechanism for minimising public losses from government intervention while imposing losses on shareholders and unsecured creditors, thereby ­limiting moral hazard and mitigating any adverse impact of ­government intervention on market discipline,” Mr Bernanke said.

The Fed chairman also indicated the US central bank would release fresh guidelines on mortgage lending next week.

The S&P 500 closed up 1.71 per cent at 1,273.70, rebounding from a loss of 0.8 per cent on Monday. Oil fell to $136.04, down from last week’s record $145.85. The dollar was up 0.4 per cent versus the euro.

Copyright The Financial Times Limited 2008