Page last updated at 21:58 GMT, Thursday, 10 July 2008 22:58 UK

US seeks to calm investor fears

Federal Reserve chairman Ben Bernanke
Ben Bernanke has called for extra powers to protect the US economy

The heads of the Federal Reserve and the US Treasury have moved to calm fears about the financial health of the nation's two largest mortgage firms.

Shares in Fannie Mae and Freddie Mac hit 17-year lows in Thursday trading amid talk of a government bail-out.

Ben Bernanke and Henry Paulson also called for new powers to shield the economy from crises such as the collapse of a Wall Street firm.

They told the US Congress they needed to modernise the regulatory system.


Mr Paulson, the Treasury Secretary, and Mr Bernanke, head of the Federal Reserve, told a hearing of the House Financial Services Committee that Fannie Mae and Freddie Mac had adequate capital.

Investors fear the two mortgage firms may need a government bail-out, after comments from a former central banker that suggested the institutions might not be solvent.

Both firms are raising funds to cover losses of more than $11bn (5.6bn) since the credit crisis began last year.

"Fannie Mae and Freddie Mac are also working through this challenging period," Mr Paulson said.

"They play an important role in our housing markets today and need to continue to play an important role in the future. Their regulator has made clear that they are adequately capitalised."

Freddie Mac and Fannie Mae were created by the US government to make it easier for more people to get on the housing ladder.

They were later privatised, but are still known as government-sponsored enterprises and are able to borrow at a lower rate of interest, because markets believe that they would not be allowed to go bankrupt.

Freddie Mac shares slid 22% to $8 and Fannie Mae lost 13.8 % to $13.20 on Thursday.


Mr Bernanke said that while current efforts were being concentrated on steadying the state of the US economy, it was not too early to consider measures to ensure the "orderly" liquidation of finance firms on the verge of bankruptcy in the future.

The Fed was forced to come to the rescue of investment bank Bear Stearns in March, which faced near collapse before it was bought out by JP Morgan in a deal engineered by the central bank.

The Federal Reserve chairman suggested a more formal process should be established to determine when to use any new powers.

He also said the Treasury should take a leading role in any process, given the financial implications of a Wall Street firm failing.

The US already has a defined system in place for dealing with insolvent commercial banks.

Under these regulations, the Federal Deposit Insurance Corporation has powers to act as a receiver for the insolvent bank and to make liquidation easier.

While Mr Bernanke conceded that the method was not directly applicable to investment banks, like Bear Stearns, and would be "complex" to establish, he said it would be "worth the effort".

"By setting a high bar for such actions, the adverse effects on market discipline would be minimised," said Mr Bernanke.

The Treasury should consult with the company's regulator and other authorities, he added.

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