Capital markets called 'impaired'

N.Y. Fed president endorses action

WASHINGTON - New York Federal Reserve Bank president Timothy Geithner said capital markets are still "substantially impaired" and policy makers and financial industry leaders must "act forcefully" to stem the crisis.

"What we were observing in US and global financial markets was similar to the classic pattern in financial crises," Geithner said in testimony to the Senate Banking Committee yesterday. He cited "a self-reinforcing downward spiral" of asset sales, "higher volatility and still lower prices."

The New York Fed chief also said the central bank's emergency actions to rescue Bear Stearns Cos. were aimed at halting a crisis that would have caused "protracted" damage to the economy. Fed chairman Ben S. Bernanke told lawmakers that while the aid wasn't a Fed bailout of Bear Stearns, it was true that the central bank "bailed out the markets in general."

Fed officials are trying to defend the aid to Bear Stearns as an emergency move to avert deeper damage to the US financial system. Lawmakers are scrutinizing the deal, concerned that government funds may be at risk and that regulators failed to recognize the mounting crisis.

Securities and Exchange Commission chairman Christopher Cox defended his agency's performance during the Bear Stearns collapse, telling lawmakers the SEC succeeded in protecting consumers. Bear's brokerage clients were "fully protected," achieving the SEC's mandate, he said at the hearing.

Fed officials have noted the SEC is the prime regulator of investment banks. Asked whether supervisors should have known about Bear's deteriorating conditions, Geithner said "it's hard to know," given that collapses "can happen very fast."

Senate Banking Committee chairman Christopher Dodd, a Connecticut Democrat, said the SEC was "seemingly unaware" of Bear Stearns's plight.

Bear Stearns chief executive Alan Schwartz said in testimony that the fifth-largest US securities firm may have survived if the Fed acted sooner to lend money directly to investment banks. "It is highly, highly unlikely in my personal opinion that we would be in the situation we find ourselves in today" had the Fed opened the window earlier, Schwartz said.

Geithner's 22-page testimony included a narrative on the events that led to the Fed's emergency loan for Bear Stearns, and the economic consequences if the central bank hadn't stepped in.

"Absent a forceful policy response, the consequences would be lower incomes for working families, higher borrowing costs for housing, education, and the expenses of everyday life, lower value of retirement savings, and rising unemployment," said Geithner, who was lead negotiator during the decision to finance $30 billion of illiquid Bear securities in the takeover by JPMorgan Chase & Co., the first deal of its kind.