Midday Market Roundup

Bernanke says financial markets improved, but 'still far from normal'

WASHINGTON (Thomson Financial) - Financial markets are better off today because of the various liquidity-providing actions taken by the Federal Reserve and its European counterparts, but, Fed chairman Ben Bernanke cautioned today that the central bankers and the markets are still a long way from the point when they can say the credit crisis is near its end.

There are 'welcome signs,' he said, 'but at this stage conditions in financial markets are still far from normal.'

Bernanke made no comments on monetary policy or the economic outlook in his remarks sent by satellite to a financial markets conference of the Atlanta Federal Reserve Bank.

As improvements, he cited reduced stress in the Treasury repurchase market and the decline in interest rate spreads for other debt securities.

Liquidity is better in several markets, Bernanke said, but 'ultimately, market participants themselves must address the fundamental sources of financial strains -- through deleveraging, raising new capital, and improving risk management.'

He emphasized improving risk management, especially liquidity risk management, because the sudden freezing up, or illiquidity, of so many markets at once took financial firms, financial regulators and the central banks by surprise.

A major surprise came from the notification on March 13 that Bear Stearns was suffering an old-fashioned run on the bank. Until then, Bernanke said, 'it was believed that primary dealers (of which Bear Stearns was one of 20) were not especially susceptible to runs by their creditors.'

Over the weekend of March 15-16, the Fed and the Treasury decided they could not afford to let Bear Stearns go bankrupt and they came up with a financing package for a takeover by JP Morgan Chase.

'A bankruptcy filing would have forced Bear's secured creditors and counterparties to liquidate the underlying collateral,' Bernanke said, at fire-sale prices in illiquid markets, and 'a much broader liquidity crisis might have ensued.'

In his review of the credit crisis and the Federal Reserve's responses, Bernanke, being a Fed chairman, would not use a common phrase like 'making it up as we went along,' but his description of the development of new liquidity-providing facilities sounded uncomfortably close to that.

'Some foreign central banks have been able to address the recent liquidity pressures within their existing frameworks without resorting to extraordinary measures,' he said. But the Fed 'had to use methods it does not usually employ.' It 'has had to innovate in large part to achieve what other central banks have been able to effect through existing tools.'

The Fed's systematic as opposed to ad hoc innovations included opening direct borrowing from the Fed to the other 19 primary dealer securities firms through the Primary Dealer Credit Facility.

It set up the Term Auction Facility for banks to remove the stigma of discount window borrowing.

It set up the Term Securities Lending Facility to let banks and firms substitute Treasuries for illiquid mortgage-backed debt.

And the Fed opened up all of the facilities to a much wider and riskier range of collateral than it had customarily accepted in the past.

All of these actions have raised the spectre of 'moral hazard,' whereby financial firms pursue more risky strategies because they believe there will be a central bank bailout if a crisis develops.

Bernanke conceded the problem, but said 'the problem of moral hazard can perhaps be most effectively addressed by prudential supervision and regulation that ensures that financial institutions manage their liquidity risks effectively in advance of the crisis.'

In other words, as many analysts have said is inevitable, with the government-provided liquidity will come new government regulations.

Bernanke expressed the hope that with better liquidity risk management, 'the frequency and severity of future crises should be significantly reduced.'

Wall Street turns modestly lower

US stocks declined modestly after a report on retail sales and comments from Federal Reserve Chairman Bernanke gave investors little incentive to extend the previous session's big advance, still concerned about high energy and food prices.

The Dow Jones Industrial Average fell 28.33 points to 12,847.98, with 14 of its 30 components posting early losses.

Blue chip declines were led by Hewlett-Packard, recently down 5.9% after the company said it would acquire Electronic Data Systems for $12.6 billion to better compete with IBM.

Off the Dow, shares of EDS gained 1.6%.

The S&P500 lost 1.14 points to 1,402.44, with utilities and energy fronting S&P sector declines, both off 0.7%.

Early action on the New York Mercantile Exchange had crude-oil futures climbing after the previous day's fall, with the contract for June delivery gaining 5 cents to $124.28 a barrel.

The technology-laden Nasdaq Composite shed 0.11 points to 2,488.38.

Volume on the New York Stock Exchange neared 728 million, with declining stocks edged out those advancing by a 4-to-3 ratio. On the Nasdaq, 311 million shares traded hands, and declining issues outran those advancing 7 to 5.

The Commerce Department said retail sales excluding motor vehicles climbed 0.5% in April, better than forecasts calling for a 0.2% gain.

Other early economic data included a Labor Department report that found import prices climbed 1.8% in April, largely in line with forecasts.

In a separate report, the Commerce Department reported sales at U.S. businesses jumped 1% in March, the smallest gain in a year. .........

End-of-day Market Roundup