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For release on delivery
12:15 p.m. EDT
October 15,2008

Z008 OCT 2 I P 2: ij b

Stabilizing the Financial Markets and the Economy

Remarks by
Ben S. Bernanke
Board of Governors of the Federal Reserve System
before the
Economic Club of New York
New York, New York
October 15,2008

Good afternoon. I am pleased once again to share a meal and some thoughts with the
Economic Club of New York. I will focus today on the economic and financial challenges we
face and why I believe we are well positioned to move forward. The problems now evident in
the markets and in the economy are large and complex, but, in my judgment, our government
now has the tools it needs to confront and solve them. Our strategy will continue to evolve and
be refined as we adapt to new developments and the inevitable setbacks. But we will not stand
down until we have achieved our goals of repairing and reforming our financial system and
restoring prosperity.
The crisis we face in the financial markets has many novel aspects, largely arising from
the complexity and sophistication of today's financial institutions and instruments and the
remarkable degree of global financial integration that allows financial shocks to be transmitted
around the world at the speed oflight. However, as a long-time student of banking and financial
crises, 1 can attest that the current situation also has much in common with past experiences. As
in all past crises, at the root of the problem is a loss of confidence by investors and the public in
the strength of key financial institutions and markets. The crisis will end when comprehensive
responses by political and financia11eaders restore that trust, bringing investors back into the
market and allowing the normal business of extending credit to households and firms to resume.
In that regard, we are, in one respect at least, better off than those who dealt with earlier financial
crises: Generally, during past crises, broad-based government engagement came late, usually at
a point at which most financial institutions were insolvent or nearly so. Waiting too long to
respond has usually led to much greater direct costs of the intervention itself and, more
importantly, magnified the painful effects of financial turmoil on households and businesses.
That is not the situation we face today. Fortunately, the Congress and the Administration have

-2acted at a time when the great majority of financial institutions, though stressed by highly
volatile and difficult market conditions, remain strong and capable of fulfilling their critical
function of providing new credit for our economy. This prompt and decisive action by our
political leaders will allow us to restore more normal market functioning much more quickly and
at lower ultimate cost than would otherwise have been the case. Moreover, we are seeing not
just a national response but a global response to the crisis, commensurate with its global nature.
This financial crisis has been with us for more than a year. It was sparked by the end of

u.s. housing boom, which revealed the weaknesses and excesses that had occurred in

subprime mortgage lending. However, as subsequent events have demonstrated, the problem
was much broader than subprime lending. Large inflows of capital into the United States and
other countries stimulated a reaching for yield, an underpricing of risk, excessive leverage, and
the development of complex and opaque financial instruments that seemed to work well during
the credit boom but have been shown to be fragile under stress. The unwinding of these
developments, including a sharp deleveraging and a headlong retreat from credit risk, led to
highly strained conditions in financial markets and a tightening of credit that has hamstrung
economic growth.
The Federal Reserve responded to these developments in two broad ways. First,
following classic tenets of central banking, the Fed has provided large amounts of liquidity to the
financial system to cushion the effects of tight conditions in short-term funding markets.
Second, to reduce the downside risks to growth emanating from the tightening of credit, the Fed,
in a series of moves that began last September, has significantly lowered its target for the federal
funds rate. Indeed, last week, in an unprecedented joint action with five other major central
banks and in response to the adverse implications of the deepening crisis for the economic

-3outlook, the Federal Reserve again eased the stance of monetary policy. We will continue to use
all the tools at our disposal to improve market functioning and liquidity, to reduce pressures in
key credit and funding markets, and to complement the steps the Treasury and foreign
governments will be taking to strengthen the financial system.
Notwithstanding our efforts and those of other policymakers, the financial crisis
intensified over the summer as mortgage-related assets deteriorated further, economic growth
slowed, and uncertainty about the financial and economic outlook increased. As investors and
creditors lost confidence in the ability of certain firms to meet their obligations, their access to
capital markets as well as to short-term funding markets became increasingly impaired, and their
stock prices fell sharply. Prominent companies that experienced this dynamic most acutely
included the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, the
investment bank Lehman Brothers, and the insurance company American International Group
The Federal Reserve believes that, whenever possible, the difficulties experienced by
firms in financial distress should be addressed through private-sector arrangements--for example,
by raising new equity capital, as many firms have done; by negotiations leading to a merger or
acquisition; or by an orderly wind-down. Government assistance should be provided with the
greatest reluctance and only when the stability of the financial system, and thus the health of the
broader economy, is at risk. In those cases when financial stability is broadly threatened,
however, intervention to protect the public interest is not only justified but must be undertaken
forcefully and without hesitation.
Fannie Mae and Freddie Mac present cases in point. To avoid unacceptably large
dislocations in the mortgage markets, the financial sector, and the economy as a whole, the

-4Federal Housing Finance Agency put Fannie and Freddie into conservatorship, and the Treasury,
drawing on authorities recently granted by the Congress, made financial support available. The
government's actions appear to have stabilized the GSEs, although, like virtually all other firms,
they are experiencing effects of the current crisis. We have already seen benefits of their
stabilization in the form of lower mortgage rates, which will help the housing market.
The difficulties at Lehman and AIG raised different issues. Like the GSEs, both
companies were large, complex, and deeply embedded in our financial system. In both cases, the
Treasury and the Federal Reserve sought private-sector solutions, but none was forthcoming. A
public-sector solution for Lehman proved infeasible, as the firm could not post sufficient
collateral to provide reasonable assurance that a loan from the Federal Reserve would be repaid,
and the Treasury did not have the authority to absorb billions of dollars of expected losses to
facilitate Lehman's acquisition by another firm. Consequently, little could be done except to
attempt to ameliorate the effects of Lehman's failure on the financial system. Importantly, the
financial rescue legislation, which I will discuss later, will give us better choices. In the future,
the Treasury will have greater resources available to prevent the failure of a financial institution
when such a failure would pose unacceptable risks to the financial system as a whole. The
Federal Reserve will work closely and actively with the Treasury and other authorities to
minimize systemic risk.
In the case of AIG, the Federal Reserve and the Treasury judged that a disorderly failure
would have severely threatened global financial stability and the performance of the U.S.
economy. We also judged that emergency Federal Reserve credit to AIG would be adequately
secured by AIG's assets. To protect U.S. taxpayers and to mitigate the possibility that lending to
AIG would encourage inappropriate risk-taking by financial firms in the future, the Federal


Reserve ensured that the tenns of the credit extended to AIG imposed significant costs and
constraints on the finn's owners, managers, and creditors.
AIG's difficulties and Lehman's failure, along with growing concerns about the U.S.
economy and other economies, contributed to extraordinarily turbulent conditions in global
financial markets in recent weeks. Equity prices fell sharply. Withdrawals from prime money
market mutual funds led them to reduce their holdings of commercial paper--an important source
of financing for the nation's nonfinancial businesses as well as for many financial finns. The
cost of short-tenn credit, where such credit has been available, jumped for virtually all finns, and
liquidity dried up in many markets. By restricting flows of credit to households, businesses, and
state and local governments, the tunnoil in financial markets and the funding pressures on
financial finns pose a significant threat to economic growth.
The Treasury and the Fed have taken a range of actions to address financial problems.
To address illiquidity and impaired functioning in commercial paper markets, the Treasury
implemented a temporary guarantee program for balances held in money market mutual funds to
help stem the outflows from these funds. The Federal Reserve put in place a temporary lending
facility that provides financing for banks to purchase high-quality asset-backed commercial
paper from money market funds, thus reducing their need to sell the commercial paper into
already distressed markets. Moreover, we soon will implement a new, temporary Commercial
Paper Funding Facility that will provide a backstop to commercial paper markets by purchasing
highly rated commercial paper directly from issuers at a tenn of three months when those
markets are illiquid.
To address ongoing problems in interbank funding markets, the Federal Reserve has
significantly increased the quantity of tenn funds it auctions to banks and accommodated

-6heightened demands for temporary funding from banks and primary dealers. Also, to try to
mitigate dollar funding pressures worldwide, we have greatly expanded reciprocal currency
arrangements (so-called swap agreements) with other central banks. Indeed, this week we
agreed to extend unlimited dollar funding to the European Central Bank, the Bank of England,
the Bank of Japan, and the Swiss National Bank. These agreements enable foreign central banks
to provide dollars to financial institutions in their jurisdictions, which helps improve the
functioning of dollar funding markets globally and relieve pressures on U.S. funding markets. It
bears noting that these arrangements carry no risk to the U.S. taxpayer, as our loans are to the
foreign central banks themselves, who take responsibility for the extension of dollar credit within
their jurisdictions.
The expansion of Federal Reserve lending is helping financial firms cope with reduced
access to their usual sources of funding and thus is supporting their lending to nonfinancial firms
and households. Nonetheless, the intensification of the financial crisis over the past month or so
made clear that a more powerful, comprehensive approach involving the fiscal authorities was
needed to address these problems more effectively. On that basis, the Administration, with the
support of the Federal Reserve, asked the Congress for a new program aimed at stabilizing our
financial markets. The resulting legislation, the Emergency Economic Stabilization Act,
provides important new tools for addressing the distress in financial markets and thus mitigating
the risks to the economy. The act allows Treasury to buy troubled assets, to provide guarantees,
and to inject capital to strengthen the balance sheets of financial institutions. The act also raises
the limit on deposit insurance from $100,000 to $250,000 per account, effectively immediately.
The Troubled Asset Relief Program (T ARP) authorized by the legislation will allow the
Treasury, under the supervision of an oversight board that I will head, to undertake two highly

-7complementary activities. First, the Treasury will use the TARP funds to help recapitalize our
banking system by purchasing non-voting equity in financial institutions. Details of this program
were announced yesterday. Initially, the Treasury will dedicate $250 billion toward purchases of
preferred shares in banks and thrifts of all sizes. The program is voluntary and designed both to
encourage participation by healthy institutions and to make it attractive for private capital to
come in along with public capital. We look to strong institutions to participate in this capital
program, because today even strong institutions are reluctant to expand their balance sheets to
extend credit; with fresh capital, that constraint will be eased. The terms offered under the
T ARP include the acquisition by the Treasury of warrants to ensure that taxpayers receive a
share of the upside as the financial system recovers. Moreover, as required by the legislation,
institutions that receive capital will have to meet certain standards regarding executive
compensation practices.
Second, the Treasury will use some of the resources provided under the bill to purchase
troubled assets from banks and other financial institutions, in most cases using market-based
mechanisms. Mortgage-related assets, including mortgage-backed securities and whole loans,
will be the focus of the program, although the law permits flexibility in the types of assets
purchased as needed to promote financial stability. Removing these assets from private balance
sheets should increase and liquidity and promote price discovery in the markets for these assets,
thereby reducing investor uncertainty about the current value and prospects of financial
institutions. Unclogging the markets for mortgage-related assets should put banks and other
institutions in a better position to raise capital from the private sector and increase the
willingness of counterparties to engage. With time, the provision of equity capital to the banking

-8system and the purchase of troubled assets will help credit flow more freely, thus supporting
economic growth.
These measures will lead to a much stronger financial system over time, but steps are also
necessary to address the immediate problem oflack of trust and confidence. Accordingly, also
announced yesterday was a plan by the Federal Deposit Insurance Corporation (FDIC) to provide
a broad range of guarantees of the liabilities of FDIC-insured depository institutions, including
their associated holding companies. The guarantee covers all newly issued senior unsecured
debt, including commercial paper and interbank funding, and it will also cover all funds held in
non-interest-bearing transactions accounts, such as payroll accounts. This broad guarantee will
be effectively immediately, and fees for coverage will be waived for 30 days. After the 30-day
grace period, banks may continue to participate in the guarantee program by paying reasonable
I would like to stress once again that the taxpayers' interests were very much in our
minds and those ofthe Congress when these programs were designed. The costs of the FDIC
guarantee are expected to be covered by fees and assessments on the banking system, not by the
taxpayer. In the case of the T ARP program, the funds allocated are not simple expenditures, but
rather acquisitions of assets or equity positions, which the Treasury will be able to sell or redeem
down the road. Indeed, it is possible that taxpayers could tum a profit from the program,
although, given the great uncertainties, no assurances can be provided. Moreover, the program is
subject to extensive controls and to oversight by several bodies. The larger point, though, is that
the economic benefit of these programs to taxpayers will not be determined primarily by the
financial return to T ARP funds, but rather by the impact of the program on the financial markets
and the economy. If the TARP, together with the other measures that have been taken, is


successful in promoting financial stability and, consequently, in supporting stronger economic
growth and job creation, it will have proved itself a very good investment indeed, to everyone's
Stabilization of the financial markets is a critical first step, but even if they stabilize as we
hope they will, broader economic recovery will not happen right away. Economic activity had
been decelerating even before the recent intensification of the crisis. The housing market
continues to be a primary source of weakness in the real economy as well as in the financial
markets, and we have seen marked slowdowns in consumer spending, business investment, and
the labor market. Credit markets will take some time to unfreeze. And with the economies of
our trading partners slowing, our export sales, which have been a source of strength, very
probably will slow as well. These restraining influences on economic activity, however, will be
offset somewhat by the favorable effects of lower prices for oil and other commodities on
household purchasing power. Ultimately, the trajectory of economic activity beyond the next
few quarters will depend greatly on the extent to which financial and credit markets return to
more normal functioning.
Inflation has been elevated recently, reflecting the steep increases in the prices of oil,
other commodities, and imports that occurred earlier this year, as well as some pass-through by
firms of their higher costs of production. However, expected inflation, as measured by consumer
surveys and inflation-indexed Treasury securities, has held steady or eased, and prices of imports
now appear to be decelerating. These developments, together with the recent declines in prices
of oil and other commodities as well as the likelihood that economic activity will fall short of
potential for a time, should lead to rates of inflation more consistent with price stability.

- 10-

This past weekend, the finance ministers and central bank governors of the Group of
Seven industrialized countries met in Washington. We committed to work together to stabilize
financial markets and restore the flow of credit to support global economic growth. We agreed
to use all available tools to prevent failures that pose systemic risk. We affirmed we will ensure
our deposit insurance programs instill confidence in the safety of savings. We agreed to ensure
that our banks and other major financial intermediaries, as needed, can raise capital from public
as well as private sources. We further agreed that we would take all necessary steps to unfreeze
interbank and money markets, and that we will act to restart the secondary markets for mortgages
and other securitized assets. Finally, we recognized that we should take these actions in ways
that protect taxpayers and avoid potentially damaging effects on other countries. I believe that
these are the right principles for action, and I see the steps announced by our government
yesterday as fully consistent with them.
I have laid out for you today an extraordinary series of actions taken by policymakers
throughout our government and around the globe. Americans can be confident that every
resource is being brought to bear to address the current crisis: historical understanding, technical
expertise, economic analysis, financial insight, and political leadership. I am not suggesting the
way forward will be easy, but I strongly believe that we now have the tools we need to respond
with the necessary force to these challenges. Although much work remains and more difficulties
surely lie ahead, 1 remain confident that the American economy, with its great intrinsic vitality
and aided by the measures now available, will emerge from this period with renewed vigor.