Bailout Gives Fed, Bernanke Key Roles

The government's planned $700 billion bailout for the financial sector is likely to give the Federal Reserve an important oversight role and accelerate plans to change the way the Fed manages interest-rate policy.

Fed Chairman Ben Bernanke is expected to play a key role in implementing the $700 billion bailout.

Fed Chairman Ben Bernanke, who lobbied Congress for the rescue package, almost certainly will play a key role in its implementation. Early drafts of the law being considered Sunday would place the Fed chairman on an oversight board meant to monitor the new program, a role Mr. Bernanke effectively invited last week in testimony to Congress.

"I think it's very appropriate, indeed essential, for Congress to have very tough oversight over this program and that there be a set of principles under which the program operates and that there be close oversight," Mr. Bernanke said.

It's not uncommon for lawmakers to turn to the Fed for other government duties because of the Fed's reputation for nonpartisanship and technical skill. Former Fed chairman Alan Greenspan served on the oversight board of the Resolution Trust Corp., the 1990s program created to sell off assets of failed thrifts. And after Sept. 11, 2001, then-Fed Governor Edward Gramlich was named chairman of the Air Transportation Stabilization Board to oversee federal loan guarantees to airlines that suffered losses during the terrorist attacks. Fed Vice Chairman Donald Kohn later became the board's chairman.

Under the rescue plan, lawmakers also sought to give the Fed more flexibility in how it runs its operations. According to drafts circulating on Sunday, lawmakers would accelerate the date the Fed could begin paying interest on the reserves banks leave on deposit with the central bank, something it doesn't do now. Such a step would give the Fed more flexibility, by making it easier for the central bank to keep short-term interest rates at their targeted level.

Congress had planned to allow the Fed to begin paying interest on reserves in October 2011, but the draft of the rescue law permits that to happen next week instead.

Currently, the Fed manages interest rates through transactions with banks using its stockpile of Treasury securities holdings. In recent months, the Fed has put that stockpile to other uses -- including lending out those Treasury securities to Wall Street firms in need of reliable collateral to fund their operations. By paying interest on reserves banks leave with it, the Fed would be able to keep short-term interest rates where it wants them, and potentially widen its use of its balance sheet for other purposes.

Central bank officials return to work Monday with short-term bank funding markets still in deep distress, something that last week prompted the Federal Reserve Bank of New York to inject repeated rounds of cash into the global financial system, through arrangements with other central banks to send dollars oversees and through its own direct market operations.

The $700 billion rescue plan will help to alleviate pressure on the Fed in other ways. By helping banks to take bad assets off of their own balance sheets, it lowers the likelihood of the kind of market chaos that shocked officials in the past two weeks. Through its lending operations, the Fed has taken riskier assets on to its own balance sheet in recent months.

"This plan uses fiscal policy to help fix a balance sheet problem in America's financial system and provides a capital infusion for the system itself, which is something that the Fed really could not do," said Richard Berner, Morgan Stanley economist.

The continuing Fed role in the $700 billion bailout is also bound to keep Mr. Bernanke in the political spotlight. Throughout the crisis, Fed officials sought to let the Treasury and Congress handle cases that might involve the direct use of taxpayer funds. Even when the Fed had the lead role, such as dealing with potential financial-system disruptions from Bear Stearns's failure, the Fed deferred to Treasury Secretary Henry Paulson and consulted with lawmakers before acting.

But Treasury officials made sure to keep the Fed close at their side. When Treasury officials planned their initial response to Fannie Mae and Freddie Mac in July, seeking greater congressional authority over the two firms, Mr. Paulson included a provision giving the Fed a "consultative role" with another regulator in setting the two firms' capital requirements.

The Fed chairman joined Mr. Paulson at emergency meetings with President Bush and congressional leaders 10 days ago to urge quick action. Over the course of the following week, he participated in numerous conference calls and private meetings along with three long hearings.

By: John Hilsenath and Sudeep Reddy
The Wall Street Journal; September 30, 2008