In additional, prepared comments that were not published prior to delivery, Fed Chairman Ben Bernanke clarified exactly why the Treasury needs to take such extraordinary action to save the financial market.
Bernanke said there are complex securities worth billions of dollars, but pricing them is not easy because there is not an active market for them. The result, he said, is two different prices: the fire-sale price and the hold-to-maturity price.
Given the "serious uncertainty" in valuing those securities, Bernanke said the Treasury's plan to purchase the illiquid assets will offer a basis for other banks to establish reasonable hold-to-maturity prices.
"I believe that under the Treasury program, auctions and other mechanisms could be designed that will give the market good information on what the hold to maturity price is for a large class of mortgage-related assets. If the Treasury bids for and then buys assets at a price close to the hold to maturity price, there will be substantial benefits," said Bernanke.
Urging Congress to act as soon as possible, he said the Treasury's plan should restore confidence by bringing liquidity back into the markets, allowing banks to attract new capital, and unfreezing credit markets.
The Fed Chairman said the beneficiaries of the program will not just be those who hold such assets, but the market as a whole and the broader economy as well.
In further questioning, Bernanke said the $700 billion proposed by Paulson should be "adequate," and argued that a lesser, "underwhelming" amount would only create more problems down the road. It's important to remind the public that this is not a $700 billion "expenditure," but that the auctions from the assets will earn "good value," and potentially even more, he added.
"My interest is solely for the strength and recovery of the U.S. economy," Bernanke said.
If the action is not taken, Bernanke said houses will be foreclosed, jobs will be lost, and GDP will contract. "This is a precondition for a healthy recovery to the economy," he said. If this is not done, there will be "significant, adverse consequences" for the average person in the United States, he added.
The Chairman also said methods used in the past like the RTC have dealt with failed institutions; whereas this is "unique and new." He said firms the government is dealing with now are contracting and pulling back, not failing. They will remain in decline until the issue of complex securities is addressed.
The main text of Bernanke's testimony has yet to be delivered, though his remarks were published before markets opened this morning.
By Patrick McGee and edited by Sarah Sussman
©CEP News Ltd. 2008