Bernanke: Focus on toxic assets

Federal Reserve Chairman Ben S. Bernanke warned Tuesday that President-elect Barack Obama’s nearly $800-billion fiscal stimulus plan can’t repair the nation’s damaged economy on its own.

To ensure recovery, Bernanke said, Washington will almost certainly have to go back to the idea of buying or guaranteeing financial firms’ toxic assets.

The Fed chief signaled that he believed the new administration would have to spend most of what remained of the Bush administration’s $700-billion financial rescue package on banks and investment companies rather than on cash-strapped homeowners, as many lawmakers want.

In remarks at the London School of Economics, Bernanke said the spending program being considered by Obama and Congress “could provide a significant boost to economic activity.”

But he added that “fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system.”

The comments, coming a week before Obama’s inauguration, appeared designed to tug the incoming president’s attention away from the glitter of growth-spurring new spending and tax cuts and back to the gritty business of how to clean up the nation’s scrambled financial system.

Bernanke’s remarks also suggested that, for the first time since the start of the economic crisis in 2007, fissures might open between the White House and the Fed.

Congress approved the Troubled Asset Relief Program last fall with the understanding that the $700 billion would be used to purchase toxic mortgage assets from banks, making it easier for them to raise capital. But the legislation gave broad authority to Treasury Secretary Henry M. Paulson, who concluded that the purchases would take too long and instead used half the money to prop up faltering firms by investing in them.

Analysts say Bernanke is on firm economic ground in pressing for additional help for the financial sector. Although most banks and investment houses appear to have stabilized since last fall and there are more signs of an easing of credit conditions, lending overall remains constrained.

Economists studying the closest analogy to the recent U.S. troubles -- Japan’s struggle during the 1990s to come back from the collapse of both its stock and real estate markets -- have concluded that policymakers in Japan erred in not cleaning up their country’s banking system.

“You can stimulate the daylights out of an economy, but if people can’t borrow, you’re not going to get a turnaround,” said Lyle E. Gramley, a former Fed governor.

Nonetheless, Bernanke’s call for the new administration to buy or guarantee troubled assets left many listeners baffled.

The Fed chairman worked closely with Paulson selling Congress on the troubled asset program by offering elaborate explanations for how the purchase of toxic securities would help the financial system, but then stood by silently when the Treasury secretary dropped that plan of attack.

“The idea of [Bernanke] coming back to the notion of removing troubled assets now is mystifying,” said Laurence H. Meyer, a former Fed governor. “It’s one of the most confusing things I’ve ever seen.”

The political fallout from the switch in the use of TARP funds was on vivid display Tuesday as Obama met behind closed doors with Senate Democrats to lobby for the program’s remaining $350 billion, as well as his stimulus plan, while Fed and Bush administration officials were grilled by an angry House committee.

Lawmakers in both houses indicated that the new president would ultimately get the remaining TARP money.

“Nobody wants to do it . . . but you have to do TARP,” said Sen. Charles E. Schumer (D-N.Y.).

But lawmakers also said they would impose restrictions on the disbursements, including a requirement that a substantial portion of the funds go to help strapped homeowners.

“There are many of us who believe that before saying yes or no, we should be able to say, ‘Yes, if,’ ” said Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee.

And for now, at least, any expansion of the program seems politically out of the question.

“That’s probably an impossible sell,” Sen. Ben Nelson (D-Neb.) said. “I don’t think you could get anybody, even the most ardent supporter . . . to support something bigger.”

At Obama’s request, President Bush on Monday formally asked Congress for the remaining funds, which would become available to the incoming administration unless Congress voted to block them.

Senate Majority Leader Harry Reid (D-Nev.) said he was confident that the Senate would defeat any move to block the money.

Senate Democrats said Obama told them that if Congress passed a resolution of disapproval to block the funds, he was prepared to veto the move.

--

peter.gosselin@latimes.com

jim.puzzanghera @latimes.com

Times staff writer Maura Reynolds in Washington contributed to this report.