Bernanke: Government bridge bank may work for Wall St

By Karey Wutkowski

ARLINGTON, Virginia (Reuters) - Federal Reserve Chairman Ben Bernanke on Tuesday fleshed out how regulators might unwind a failing investment bank in an orderly manner, saying the current approach for dealing with insolvent commercial banks might be an appropriate model.

Bernanke's comments followed a call last week from Treasury Secretary Henry Paulson that U.S. regulators must have a way to allow investment banks to fail without threatening the stability of the broader financial system.

"Congress may wish to consider whether new tools are needed for ensuring an orderly liquidation of a systemically important securities firm that is on the verge of bankruptcy, together with a more formal process for deciding when to use those tools," Bernanke said during a mortgage lending forum sponsored by the Federal Depositary Insurance Corp.

In March, the Fed helped engineer a takeover of Bear Stearns by JPMorgan Chase & Co, and guaranteed a $29 billion loan to facilitate the transaction, out of concern that a Bear Stearns bankruptcy could trigger a financial panic.

Bernanke said on Tuesday that those actions were warranted but said the Fed only used its lending powers because no other tools were available at the time to mitigate the impact of Bear Stearns' collapse.

He said that "one possible model" is the FDIC's authority to act as a receiver for an insolvent commercial bank and to set up a so-called bridge bank to liquidate it in an orderly manner.

"A bridge bank authority is an important mechanism for minimizing 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," Bernanke said.

FDIC Chairman Sheila Bair has said in recent weeks that the agency's power to take over and sell the assets of failed commercial banks serves as a good model for investment banks.

Bair told Reuters on Tuesday that Bernanke's support for such a plan could add some momentum for getting Congress to act on it. "It's the direction we need to go in. We're getting a growing consensus," she said.

But she said drafting and passing legislation will be difficult and is not likely to happen until next year.

Regulators have been concerned about creating a perception that banks are too big to fail, thereby encouraging them to take on excessive risk with the knowledge that the government will bail them out.

During the Bear Stearns collapse, the Fed started making emergency loans to investment banks for the first time since the Great Depression. That stop-gap measure was due to expire in September, but Bernanke said on Tuesday that the Fed could extend the lending facility past the end of the year.

Regarding a plan to safely unwind a failing investment bank, Bernanke said crafting such a plan will be difficult because securities firms differ significantly from most commercial banks in their financing and business models.

"Despite the complexities of designing a resolution regime for securities firms, I believe it is worth the effort," he said. "In particular, by setting a high bar for such actions, the adverse effects on market discipline could be minimized."

Bernanke also said the Treasury should take a leading role in the resolution of a failing securities firm, in consultation with the company's regulator and other authorities.