Published March 4, 2009

US may need to ramp up US$700b bank rescue: Fed

More to be done to ensure a sustainable recovery: Bernanke

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(WASHINGTON) Federal Reserve chairman Ben Bernanke said yesterday that policymakers may need to expand aid to the US banking system beyond the US$700 billion already approved and take other aggressive measures even at the cost of soaring fiscal deficits.

'Without a reasonable degree of financial stability, a sustainable recovery will not occur,' the Fed chairman said in testimony prepared for the Senate Budget Committee. 'Although progress has been made on the financial front since last fall, more needs to be done.'

His comments suggest he sees a role for bigger federal outlays as the Obama administration seeks congressional approval for a budget of US$3.55 trillion for the fiscal year beginning in October. President Barack Obama has already signed into a law a US$787 billion economic stimulus package of tax cuts and government spending.

Mr Obama's first budget seeks standby authority for as much as US$750 billion in new aid to the financial industry. Whether those funds will be needed 'depends on the results of the current supervisory assessment of banks' and the evolution of the economy, Mr Bernanke said.

He said policymakers would have 'preferred to avoid' what is likely to be the largest ratio of federal debt compared with gross domestic product (GDP) since the end of World War II, and he urged lawmakers not to lose sight of fiscal discipline.

'But our economy and financial markets face extraordinary challenges', and doing less now would eventually prove to be more costly, he said. 'We are better off moving aggressively today to solve our economic problems; the alternative could be a prolonged episode of stagnation' that would cause budget deficits to swell further, increase unemployment and undermine incomes 'for an extended period'.

The Fed has more than doubled its assets to US$1.9 trillion during the past year by expanding loans to banks, launching programmes to revive commercial paper and other markets and backing the merger of Bear Stearns Cos with JPMorgan Chase & Co.

The 55-year-old Fed chairman told the Senate Banking Committee last week there's a 'reasonable prospect' the recession will end in 2009 'if the actions taken by the administration, the Congress and the Federal Reserve are successful in restoring some measure of financial stability'.

Fed policymakers face headwinds from equity markets, with the Standard and Poor's 500 Index falling this year by 22.5 per cent and the S&P Financials Index tumbling 44.2 per cent.

The US government is still trying to stabilise large financial institutions such as Citigroup Inc and insurer American International Group Inc. Shares of Citigroup traded at US$1.33 yesterday morning at 9:33am, and the government expanded its aid to AIG on Monday after the company reported a fourth-quarter loss of US$61.7 billion - the worst loss by any US corporation.

The spending blueprint delivered to Congress last month forecasts government spending this year of US$3.94 trillion, up 32 per cent from a year ago. That would yield a record deficit of US$1.75 trillion in the year ending Sept 30, equal to about 12 per cent of the nation's GDP - the highest since World War II. Government spending of US$3.55 trillion next year will include about US$350 billion approved as part of the stimulus package.

'By supporting public and private spending, the fiscal package should provide a boost to demand and production over the next two years as well as mitigate the overall loss of employment and income that would otherwise occur,' Mr Bernanke said.

Still, the size of the impact on the economy from government spending is 'subject to considerable uncertainty', he said. Consumers may decide to pay down debt or save their cash rather than spend it, he noted. -- Bloomberg