June 3 (Bloomberg) -- Federal Reserve Chairman Ben S.
Bernanke said large U.S. budget deficits threaten financial
stability and the government can’t continue indefinitely to
borrow at the current rate to finance the shortfall.
“Unless we demonstrate a strong commitment to fiscal
sustainability in the longer term, we will have neither
financial stability nor healthy economic growth,” Bernanke said
in testimony to lawmakers today. “Maintaining the confidence of
the financial markets requires that we, as a nation, begin
planning now for the restoration of fiscal balance.”
Bernanke’s comments signal that the central bank sees risks
of a relapse into financial turmoil even as credit markets show
signs of stability. He said the Fed won’t finance government
spending over the long term, while warning that the financial
industry remains under stress and the credit crunch continues to
limit spending.
The Fed chief said in his remarks to the House Budget
Committee that deficit concerns are already influencing the
prices of long-term Treasuries.
Yields on 10-year notes have climbed about 1 percentage
point since the Fed announced plans in March to buy $300 billion
of long-term government bonds. The notes yielded 3.54 percent at
5 p.m. in New York, down from 3.61 percent late yesterday, as
Bernanke’s warnings on the need to reduce the deficit supported
the market.
Rise in Yields
“In recent weeks, yields on longer-term Treasury
securities and fixed-rate mortgages have risen,” Bernanke said.
“These increases appear to reflect concerns about large federal
deficits but also other causes, including greater optimism about
the economic outlook, a reversal of flight-to-quality flows and
technical factors related to the hedging of mortgage holdings.”
The budget deficit this year is projected to reach $1.85
trillion, equivalent to 13 percent of the nation’s economy,
according to the nonpartisan Congressional Budget Office.
“Either cuts in spending or increases in taxes will be
necessary to stabilize the fiscal situation,” Bernanke said in
response to a question. “The Federal Reserve will not monetize
the debt.”
Bernanke also addressed banks’ efforts to bolster common
equity in the aftermath of regulators’ stress tests on the 19
largest U.S. lenders. He said the 10 firms that were found to
have a total capital shortfall of $75 billion have now sold or
announced plans to boost common equity by $48 billion.
Bank Plans
“We expect further announcements shortly” as the banks
submit plans due by June 8, Bernanke said.
This year’s projected budget deficit, four times the size
of last year’s shortfall, has been driven up mostly by costs
associated with the financial crisis.
“Bernanke knows that fiscal financing problems are already
complicating monetary policy and are in danger of undermining
Fed credibility,” said Alan Ruskin, chief international
strategist at RBS Securities Inc. in Stamford, Connecticut. “He
knows that there is only so much quantitative-easing financing
that can be done.”
A fiscal stimulus of almost $800 billion, the government’s
financial rescue effort, takeovers of Fannie Mae and Freddie Mac
and increased costs of running safety-net programs such as
unemployment insurance have added billions to spending.
President Barack Obama has pledged to halve the deficit by
the end of his term. Even if successful, his administration
anticipates the government will still run what would be, by
historical standards, large deficits for the foreseeable future.
Bernanke said the debt-to-gross domestic product ratio is set to
reach the highest since the 1950s.
‘Hard Slog’
“It is fine to have this budget deficit now,” said Alan
Blinder, a Princeton University economics professor and former
Fed vice chairman. “It will also be a long hard slog to get the
budget deficit down to a manageable level.”
House Majority Leader Steny Hoyer told reporters that
Bernanke “is absolutely right, we need to be very concerned
about incurring additional indebtedness.” The House plans to
pass legislation before its July 4 recess to cut spending in one
category before increasing it in another, he said. In addition,
“we need to address entitlements.”
Treasury Secretary Timothy Geithner, in an interview with
Bloomberg Television May 21, said the administration’s goal is
to cut the budget shortfall to 3 percent of GDP or smaller.
Rising government spending, forecasts for a record fiscal
deficit and an unprecedented expansion of central bank credit
have also fueled investor concerns that inflation will rise.
Bernanke said inflation “will remain low” as the economy
operates with slack resource use.
‘Dangerous’ Mix
Wisconsin Representative Paul Ryan, the ranking Republican
on the committee, said in opening remarks that the Treasury’s
debt issuance and the Fed’s monetary stimulus, including
purchases of government bonds, “can be a dangerous policy mix”
and risks “runaway inflation” in the longer term.
Ryan said he’s concerned about “substantial” political
pressure on the Fed to delay plans to tighten credit should
unemployment remain high.
“The Fed’s political independence is critical and
essential for safeguarding its commitment to price stability,”
Ryan said. “We policy makers should realize that our most
challenging policy period is going to be ahead of us.”
In Europe, German Chancellor Angela Merkel said yesterday
she views “with great skepticism what authority the Fed has and
the leeway the Bank of England has created for itself,” to
purchase a range of assets in their efforts to end the crisis.
She urged central banks to return to a “policy of reason.”
Asked by a lawmaker about Merkel’s comments, Bernanke said,
“I respectfully disagree with her views.”
‘Inflationary Consequences’
“I am comfortable with the policy actions that the Federal
Reserve has taken,” he said. “We are comfortable that we can
exit from those policies at the appropriate time without
inflationary consequences.”
The central bank is buying as much as $1.75 trillion of
housing debt and Treasuries this year to lower borrowing costs
across the economy after reducing the benchmark interest rate
almost to zero in December. Fed officials hold their next policy
meeting June 23-24 in Washington.
Bernanke said during the hearing he wouldn’t support any
measure that would have the Fed’s 12 regional Fed bank
presidents nominated by the White House and confirmed by the
Senate. Fed bank presidents are currently appointed by the
regional bank boards with the approval of the Board of
Governors.
To contact the reporter on this story:
Craig Torres in Washington at
ctorres3@bloomberg.net;
Brian Faler in Washington at
bfaler@bloomberg.net
Last Updated: June 3, 2009 17:09 EDT
Original Source: http://www.bloomberg.com/apps/news?pid=20601087&sid=aLGYMr_g7PSg
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