Financial thoughts

Federal Reserve Chairman Ben S. Bernanke has pushed aside central-banking tradition, scooping up $29 billion of assets from Bear Stearns Cos. and backstopping bond dealers. Congress wants to know where he draws the line.

Bernanke testifies before two congressional panels today and tomorrow. The hearings mark his first trips to Capitol Hill since the Fed's March 16 intervention to avert the bankruptcy of Bear, an extension of credit to a non-bank corporation that was unprecedented since the Great Depression.

While lawmakers praise the central bank and the Treasury Department for staving off a U.S. financial collapse, they question the propriety of subsidies to Wall Street risk-takers as hundreds of thousands of Americans lose their homes to foreclosure.

“We want to know about precedent,'' said Senator Charles Grassley of Iowa, the senior Republican on the Senate Finance Committee. If the central bank is prepared to repeat the Bear Stearns example, “it sends a very dangerous signal,'' he said in an interview with Bloomberg Television yesterday.

“People are willing to take chances if they think that the federal government is going to step in and bail them out all the time,'' Grassley added.

Bernanke, 54, will address the economy at the Joint Economic Committee today at 9:30 a.m. He appears tomorrow at the Senate Banking Committee to discuss markets and the Fed's role in JPMorgan Chase & Co.'s purchase of Bear Stearns.

Ditching Tradition

As credit markets seized up, the Fed gave all 20 primary dealers in U.S. government bonds the same access to discount- window loans. Until then, those loans had been reserved for banks. The central bank now auctions as much as $100 billion in funds to lenders a month, and has cut the cost on direct loans to just a quarter-point above the overnight rate between banks.

Lawmakers have welcomed the interest-rate reductions, including 2 percentage points of cuts since the year began, the fastest easing of monetary policy in two decades. The benchmark rate is now 2.25 percent, down from 5.25 percent in September.

At the same time, legislators have begun scrutinizing the central bank's aid to Bear Stearns, which was the biggest underwriter of mortgage-backed bonds. The market for the securities was throttled by a surge in delinquencies on subprime loans, or credit given to people with poor or incomplete credit histories. Foreclosures jumped when interest rates on the loans climbed after an initial period of lower rates.

`Historic Action'

“The administration just took historic action to support the takeover of Bear Stearns by JPMorgan Chase,'' Senate Banking Committee Chairman Christopher Dodd said yesterday on the Senate floor. “It's now time to turn our attention to Main Street.''

The Fed agreed last month to take illiquid assets off of Bear Stearns's balance sheet to encourage JPMorgan to buy the firm low fee cash advance. Most of the investments were mortgage-backed securities and “related'' items, the Treasury Department said in a March 28 letter to Senate Finance Committee staffers.

The assets will be placed in a Delaware corporation set up by the New York Fed. BlackRock Inc. will attempt to sell the assets to pay back the Fed and JPMorgan. The first $1 billion of losses, if any, will be charged to JPMorgan, and the remainder go to the Fed.

Fed officials crossed a “clear line'' between backstop funding and influencing risk in approving the deal, said Brian Sack, a senior economist at Macroeconomic Advisers LLC in Washington and former Fed Board section chief. “When you have outright ownership you are affecting the supply of risk to the private sector.''

Meeting Republicans

Bernanke told House Republican leaders yesterday that “there are still a number of issues out there that are potentially of concern, including the value of housing,'' Representative Adam Putnam of Florida told reporters yesterday. Putnam is the party's third-highest leader in the House.

The worst housing crisis in a quarter century has probably pushed the economy into a recession, according to most Wall Street economists. Private-sector payrolls have fallen for three consecutive months, retail sales dropped 0.6 percent in February, and the U.S. home foreclosure rate reached a record in the fourth quarter of 2007.

“Anything the Congress can do to stabilize that market and turn values around would be helpful,'' Bernanke told Republicans, referring to housing, Putnam said.

The Fed reinvented the role of the central bank as a lender of last resort without consulting Congress. Now, it's time to debate which firms should have access to emergency funding and when, and whether the Fed is the right supervisor for the securities firms to which it is now lending, economists say. The Treasury this week published a “blueprint'' for regulation that positioned the Fed as overseer of market stability.

`Serious Issue'

“This raises the serious issue: How do we regulate or supervise financial institutions? How many come under the umbrella of too-big-to-fail?'' Henry Kaufman, president of Henry Kaufman & Co. in New York, said in a Bloomberg Television interview. “The Federal Reserve has put a lot on the back burner when it comes to supervision and regulation'' and is “not prepared'' to take responsibility for securities firms, he added.

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