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Bernanke Warns Market Against Expectations of Future Gov't Bailouts

WASHINGTON — Federal Reserve Chair Ben Bernanke Tuesday shot down the notion that, despite the part they played in the financial crisis almost five years ago, large U.S. banks can still count on a government rescue should they face financial difficulties.

He also predicted during day one of his semiannual testimony before the Senate Banking Committee that large financial institutions will begin to downsize of their own accord as the benefits of being large wane over time.

Bernanke faced persistent questioning from Sen. Elizabeth Warren, the flag bearer for community banks and the consumer protection movement, who noted that not only have big banks grown in size since the 2008 financial crisis, but investors now view them as a safer investment over smaller banks based on the belief they enjoy an implicit guarantee from the government.

Citing a recent research by the IMF and other economists, Warren said this is a "subsidy" for big banks that amounts to $83 billion.

"The subsidy is coming because of market expectations that the government would bailout these firms if they get into trouble," Bernanke responded, and warned that "those expectations are incorrect."

The passage of the 2010 Dodd-Frank Act granted regulators the authority to orderly liquidate large banks, he said, meaning "now we have the tools."

So even though investors expect that the government would step in, "that doesn't mean that we have to do it," Bernanke told Warren.

"Too-big-to fail" is not an absolute, Bernanke continued, noting that there are spreads and credit default swaps that indicate there is "some probability" of failure.

He also pointed to the fact many of these firms have had their credit and government support ratings downgraded.

However, this does not change the fact that authorities still have a lot more to do.

"We are in complete agreement that we need to stop too-big-to fail," Bernanke said. "We are putting a lot of effort into this, it's a problem that we've had for a very long time.

"We do have a plan and I think it's moving in the right direction," he added, predicting that over time there will be an increasing realization in the markets that a large financial institution that gets into trouble will be allowed to fail.

Harking back to the dark days of the 2008 financial meltdown, Bernanke said he would "very much like" to have the confidence that regulators could close down a large institution without causing damage to the rest of the economy.

In addition, "I would make another prediction ... that the benefits of being large are going to decline over time, which means that some banks are going to voluntarily begin to reduce their size because they are not getting the benefit that they used to get," Bernanke said.

Market News International is a real-time global news service for fixed-income and foreign exchange market professionals. See www.marketnews.com.

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