Bernanke: Public-private partnership required to value toxic assets

The involvement of both the public and private sectors is essential to accurately value illiquid assets before public funds are used to remove them from dealer balance sheets, Federal Reserve chairman Ben Bernanke claimed yesterday.

Appearing before the Senate Banking Committee to present his semi-annual monetary policy report, Bernanke faced questions from senators anxious to hear more details about the vaguely sketched out $1 trillion Public-Private Investment Fund. The fund was announced by Treasury secretary Timothy Geithner on February 10 to target the illiquid assets burdening financial institutions and disrupting the extension of credit to small business.

However, in depth explanations of how the fund would work weren't forthcoming as senators asked what role public funds would play alongside the private sector.

"We're using all our supervisory tools to come to the most accurate valuations and using a public-private partnership is a good idea to come to that valuation," said Bernanke. "If both the public and private purse are used to value securities there is better chance the price we come to will reflect the true market reality rather than accounting fiction. That is why the private sector should be involved in the asset-purchase programme."

The chairman went on to provide some illumination around the bank stress tests scheduled to begin today to determine the further capital requirements of the 20 major US banking institutions, defined as holding more than $100 billion in assets.

Under the plan, should stress assessments indicate an additional capital buffer is warranted, the government will provide fund injections to protect against expected future losses over the near term, in the form of mandatory convertible preferred shares, which would be converted into common equity shares only as needed over time to keep banks well-capitalised.

Some senators were vocally uncomfortable with the notion of even further cash injections for banks, with ranking member Richard Shelby asking whether conducting stress tests was appropriate, given that the government is "propping up banks" that he characterised as "walking dead".

Shelby went on to refer directly to reports that federal regulators are in secret talks with Citigroup to allow the government to take a 40% stake in the firm in exchange for a third capital infusion by converting the US government's $45 billion in preferred shares into common stock. He noted that a 40% holding would give US authorities "working control of the boardroom", but admitted he did not find that outcome desirable.

"We're trying to evaluate how much capital these banks need - the outcome of the stress test is not a fail or pass but how much capital does a bank need to meet the credit needs of borrowers," Bernanke responded. "We don't need majority ownership to work with banks. I don't see any need to destroy the franchise value or create the huge legal uncertainties of trying to formally nationalise a bank when it isn't necessary," he added.

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