WASHINGTON (Reuters) - Federal Reserve Chairman Ben Bernanke warned on Tuesday the “severe” U.S. recession could drag into next year, but said banks should be able to weather the downturn without being nationalized, cheering markets.
“I don’t see any reason to destroy the franchise value or to create the huge legal uncertainties of trying to formally nationalize a bank when it just isn’t necessary,” Bernanke told the Senate Banking Committee.
“What we can do is make sure they have enough capital to fulfill their function and at the same time we exert adequate control to make sure that they are doing what is necessary to become healthy and viable over the longer term,” he added.
U.S. stocks, which hit a 12-year low on Monday, jumped as investors set aside fears bank shareholders could get wiped out as the government moves to prop up the sector. The broad Standard & Poor’s 500 Index shot up 4 percent.
“The plan out of the administration with Bernanke’s backing seems to have some rationality and the market is factoring that there is something here that might potentially work,” said Greg Palmer, head of equity trading at Pacific Crest Securities in Portland, Oregon.
Still, Bernanke was somber in his assessment of the economy. If efforts to stabilize banks failed, he said, the fast-shrinking economy could enter a mutually reinforcing cycle of weak growth and financial strain.
“To break the adverse feedback loop, it is essential that we continue to complement fiscal stimulus with strong government action to stabilize financial institutions and financial markets,” he said.
“If actions taken by the administration, the Congress and the Federal Reserve are successful in restoring some measure of financial stability -- and only if that is the case, in my view -- there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery,” Bernanke added.
The U.S. housing bust has saddled banks worldwide with big losses, leading them to cut back on lending, weakening economies. Governments are grappling with how best to restore the financial system to health and revive economic growth.
In the United States, policy-makers are moving into the second phase of a $700 billion financial rescue program, with plans to invest in banks that need capital in return for preferred shares that could convert over time to common stock.
“We are committed to ensuring the viability of all major financial institutions,” Bernanke said.
U.S. regulators will begin “stress tests” at the nation’s 19 largest banks on Wednesday. Bernanke said the tests aim to judge whether banks can keep lending even under unexpected economic strains.
Regulators want “to ensure that even in a bad scenario, banks will have enough capital, including enough common equity, to meet their obligations to lend,” Bernanke said.
He expressed faith that authorities were on the right path in taking time to fully diagnose the health of the top banks.
“Our major banks have significant franchise values,” Bernanke said. “There is no commitment by any means to never shut down a big bank, absolutely not, but I do believe that the major banks we have now can be stabilized.”
The Fed chairman warned that the global nature of the economic slowdown could sap U.S. exports and harm financial conditions to a greater degree than currently expected.
A slump in U.S. exports as world growth slowed last year added to a deep pullback in consumer spending that steepened the downward slide in the U.S. economy.
Bernanke said the Fed, which has dropped rates to nearly zero, would keep borrowing costs exceptionally low for some time and pledged to use “all available tools” to stimulate the economy and heal financial markets.
He said the central bank had not ruled out buying longer-term U.S. government bonds to drive down borrowing costs, but said its immediate focus was on other steps to lower mortgage rates and spur consumer lending.
Some of the measures the central bank has already taken had helped ease tight conditions in some credit markets, Bernanke said.
“Nevertheless, despite these favorable developments, significant stresses persist,” he said.