Bernanke: No exit yet

Colin Barr, senior writer


NEW YORK (Fortune) -- Ben Bernanke has a handy tool belt, but don't expect to see him sporting it until next year.

The Federal Reserve chairman on Wednesday spelled out how he plans to mop up all the money the central bank has spilled into the economy to douse a financial conflagration. He presented the plan in written testimony for a congressional hearing that was snowed out.

The Fed's so-called exit strategy is important because even in the midst of the deepest economic downturn in seven decades, policymakers have been hounded by worries that any return to sustained growth in coming years will ignite an inflationary firestorm.

Bernanke identified several tools that he said would help drain the $1.1 trillion of excess reserves sloshing around the banking system. They include paying interest on bank reserve balances and possibly selling some of the mortgage debt the Fed has acquired to shore up the housing market.

Pulling those levers should help the Fed limit credit creation when the economy begins to bounce back, Bernanke said.

But given continued weakness in the domestic economy and worries about financial contagion in Europe, no one should expect to see Bernanke brandishing his tools any time soon.

While the economy has bounced back from its near collapse in late 2008, one in six workers still can't find enough work, going by the government's broadest measure of unemployment. Bank lending has dried up, with commercial bank loans down 8% from their level at the end of 2008.

The housing market has pulled out of free fall - but mostly because of the homebuyer tax credit, which subsidized purchases, and the Fed's purchase of $1.4 trillion worth of mortgage-related debt, which pushed down mortgage rates.

Those purchases are due to end next month, at which time observers expect mortgage rates to rise. All else equal, a rise in rates stands to send housing prices lower - leaving banks with more losses and growing holdings of hard-to-sell properties, and further restraining the credit growth needed for a full recovery.

With the economy so fragile, it's hardly shocking that Bernanke is in no rush to tinker with the economics of the housing market.

"I currently do not anticipate that the Federal Reserve will sell any of its security holdings in the near term, at least until after policy tightening has gotten under way and the economy is clearly in a sustainable recovery," Bernanke said in his testimony Wednesday.

What's more, some Fed members think the central bank may yet need to buy more securities to keep the economy from backsliding. Among those is St. Louis Fed President James Bullard, who said last month in a speech in China the Fed should "allow for the adjustment of asset purchases as new information on the economy becomes available."

If the domestic picture weren't downbeat enough, consider the markets' reaction to the European Central Bank's efforts to ease itself out of the free money business. The bank's decision in December to tighten collateral terms is now seen as one of the factors that led to this year's funding crisis in Greece.

Even if the Fed ignored the market consequences of tighter policies, there is the question of how strong the economy's momentum really is.

Any financial support for Greece or for other troubled euro nations will surely be predicated on sharp spending cutbacks in those countries - which will depress growth in those nations as well as in their trading partners.

A similar dynamic is playing out in the U.S., where growth may stumble in the second half as strapped states and municipalities slash their budgets anew and federal stimulus payments begin to peter out.

Even in China, whose quick return to growth is viewed in some quarters as a sort of global economic savior, is pulling back on credit expansion following a lending boom last year.

Budget cuts and tighter money are "certainly going to pose a drag on growth forecasts in the continent and globally as well," Gluskin Sheff economist David Rosenberg wrote Wednesday in a note to clients.

Good reason for Bernanke to leave his tools in the garage for now. To top of page

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