New York Federal Reserve Bank President Timothy Geithner said capital markets are still ``substantially impaired'' and policy makers and financial industry leaders must ``act forcefully'' to stem the crisis.
``What we were observing in U.S. and global financial markets was similar to the classic pattern in financial crises,'' Geithner said in his prepared testimony to the Senate Banking Committee. He cited ``a self-reinforcing downward spiral'' of asset sales, ``higher volatility, and still lower prices.''
The New York Fed chief also said that the central bank's emergency actions to rescue Bear Stearns Cos. were aimed at halting a ``classic'' financial crisis that would have caused ``protracted'' damage to the U.S. economy.
Fed officials are trying to defend the aid to Bear Stearns as an emergency move to avert deeper damage to the U.S. financial system. Lawmakers are investigating the deal, concerned that government funds may be at risk and that regulators failed to recognize the mounting crisis.
Geithner's 22-page testimony included a narrative on the events that led to the Fed's emergency loan for Bear Stearns, and the economic consequences if the central bank hadn't stepped in.
Economic Consequences
``Absent a forceful policy response, the consequences would be lower incomes for working families, higher borrowing costs for housing, education, and the expenses of everyday life, lower value of retirement savings, and rising unemployment,'' said Geithner, who was lead negotiator during the decision to finance $30 billion of illiquid Bear securities in the takeover by JPMorgan Chase & Co., the first transaction of its kind.
The New York Fed presented a one-page description of the portfolio. The assets include investment-grade securities and residential and commercial mortgage loans, all of which were current on principal and interest as of March 14.
The portfolio also holds collateralized mortgage obligations, most of which are bonds of government-sponsored enterprises such as Freddie Mac and Fannie Mae. The holdings include asset-backed securities, adjustable-rate mortgages, commercial mortgage-backed securities and collateralized mortgage obligations issued by companies other than government-chartered companies.
Geithner, vice chairman of the Fed's interest-rate setting Open Market Committee, said the Fed's actions to date ``have helped avert substantial damage to the economy, and they have brought a measure of tentative calm to global financial markets.''
``Policy makers and financial market participants need to continue to act forcefully,'' and ``their actions need to be proportionate to the challenges,'' Geithner said.
``The Federal Reserve System's response has helped reduce the risk of systemic damage to the financial system and thereby helped mitigate a potential source of downside risk to growth,'' he added.
Geithner, 46, has advised the board on several efforts by the Fed that increased credit to financial institutions in the past seven months.
Money Markets
The New York Fed administers the System Open Market Account, which is involved in money markets on an almost daily basis to set the federal funds rate, the main policy rate, which now stands at 2.25 percent.
The New York Fed manages the Primary Dealer Credit Facility, an overnight-loan mechanism set up for government bond dealers after the Bear Stearns rescue, and the Term Securities Lending Facility, which allows bond dealers to swap their mortgage securities for the Fed's holdings of Treasury notes for 28 days.
He answered critics who say the Fed, by engineering the rescue of Bear Stearns and increasing credit available to investment banks, has encouraged excessive risk-taking on Wall Street.
``We believe that the lesson of the actual outcome for equity holders will serve to check and even diminish incentives for undue risk-taking,'' he said.
Geithner also presented lawmakers with an outline for overhauling the regulation of financial markets and banks, which spans more than a half-dozen agencies.
The FOMC has lowered the benchmark rate 3 percentage points since September, to 2.25 percent. Fed Chairman Ben S. Bernanke told lawmakers yesterday for the first time that a recession is possible this year.
Geithner took the helm of the New York Fed in 2003, and previously worked as a Treasury undersecretary in the Clinton administration, when he helped coordinate the U.S. response to the Asian financial crisis.
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