Bernanke defends big bank bailouts

The Fed chairman also said that banks becoming too big to fail is an 'enormous problem.' FDIC's Sheila Bair calls for more regulation to solve banking crisis.

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By David Ellis, CNNMoney.com staff writer

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What should the government do about AIG bonuses?
  • Tax them
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  • Nothing, a contract's a contract

NEW YORK (CNNMoney.com) -- Federal Reserve Chairman Ben Bernanke responded to ongoing criticism of the government's efforts to keep alive institutions it has deemed "too big to fail," saying that this is an "enormous problem" that needs to be addressed.

Speaking before a group of community bankers in Phoenix, the central bank chief argued that actions taken thus far to prop up the nation's largest banks have been extremely unpleasant, but necessary to preventing further harm across financial markets and the broader economy.

"I do not think we have had a realistic alternative to preventing such failures," he said.

Many smaller community banks avoided making too many subprime mortgages and also did not own the types of toxic securities backed by these loans that have plagued big banks.

These smaller banks, along with taxpayers, have become increasingly frustrated by the government's stance that major financial institutions like Citigroup (C, Fortune 500), Bank of America (BAC, Fortune 500) and American International Group (AIG, Fortune 500) continue to require billions of dollars in government support because they have been viewed as too big and important to the broader economy to fail.

Those remarks were echoed by Sheila Bair, chairman of the Federal Deposit Insurance Corp., who addressed the same industry group Friday.

In her prepared comments, Bair reiterated comments she made before the Senate Banking Committee Thursday, adding that ending the "too to big to fail" issue required a number of new tools including a systemic risk regulator and a program that would help resolve problems at a large financial institution, similar to how the FDIC handles other banks that fail.

"I hope Congress acts soon," she said. "Nobody wants to go through another banking crisis like this one."

Bair also reiterated previously made remarks that she expected bank failures to cost about $65 billion over the next five years. The FDIC recently moved to raise assessments fees charged to banks to fund the industry's deposit insurance fund, which is used to cover deposits when a bank fails.

She also repeated an earlier assertion that without "additional revenue beyond the regular assessments, current projections indicate that the fund balance will approach zero."

With that in mind, Senate Banking Committee Chairman Chris Dodd, D-Conn. and Sen. Mike Crapo, R-Idaho have already proposed a bill that would allow the FDIC to borrow up to $500 billion from the government to shore up the fund.

But even though many big banks face significant challenges, Bernanke and Bair urged the community bankers in attendance Friday to keep lending.

Local lenders have become a key source of credit at a time when large banks and other finance firms outside the reach of regulatory agencies have withdrawn massive amounts of credit from the nation's financial system.

Community banks, which typically have $1 billion in assets or less, logged a 1.5% increase in outstanding loans as of the end of the fourth quarter. The largest institutions, with assets of more than $100 billion, suffered a 3.4% decline.

By continuing to make prudent loans, not only will community banks help the U.S. economy recover, but they also stand to benefit from the new business, according to the two regulatory chiefs.

"Community bankers are vitally important to our country and our economy," said Bair.

Hectic week in Washington

Friday's comments by Bernanke and Bair cap what has been a particularly busy week for the Fed chief and other regulators.

On Wednesday, Bernanke and fellow members of the Fed's Federal Open Market Committee, which sets interest rates, unveiled plans to purchase massive amounts of government debt over the next six months to help keep long-term rates low and get credit flowing again.

In a televised interview with 60 Minutes last Sunday, Bernanke said that a "depression" can be avoided, but he acknowledged that a full economic recovery will take time and that the financial system must be fixed in order for the recession to end.

Next week, Bernanke is slated to testify before Congress about the government's extensive efforts to rescue AIG and the controversy over the insurer's decision to pay $165 million in bonuses. Treasury Secretary Timothy Geithner will also appear at that hearing.  To top of page

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