Ben Bernanke, chairman of the US Federal Reserve, warned yesterday that the economic recovery package planned by the incoming Obama administration will not succeed unless financial stability is restored.
Mr Bernanke used a speech in London to issue a clear challenge to the US president-elect, Barack Obama, who is planning a huge fiscal stimulus – expected to be worth $775bn (£535bn) – to get the US economy going again.
He said: "Fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilise and strengthen the financial system."
Delivering the Stamp Lecture at the London School of Economics, Mr Bernanke spelt out what those "further measures" might entail.
They include further recapitalisations of financial institutions; purchases of "toxic debts" under the troubled assets relief programme (the Tarp), or government guarantees of their value; purchases of commercial paper, and, possibly, government securities; and a clear signal that "economic conditions are likely to warrant an unusually low federal funds rate for some time".
The Fed has already announced its intention to buy $600bn worth of Fannie Mae and Freddie Mac debt and mortgage-backed securities. In addition, the possibility of a "bad Bank" was floated yesterday by Mr Bernanke. This would purchase assets from financial institutions in exchange for cash and equity in the new vehicle.
However, the commercial banks would never again be allowed to become "too big to fail", the Fed's chairman added. "It is unacceptable that large firms that the government is now compelled to support to preserve financial stability were among the greatest risk-takers during the boom period... they must accept especially close regulatory scrutiny of their risk-taking."
Mr Bernanke's remarks were echoed by those given in evidence to a Treasury Select Committee hearing on the banking crisis and its effects on the UK. Jon Moulton, founder of Alchemy Partners, told MPs on the committee that the banks had become "too damn complicated" and impossible to regulate or manage. He called for "narrow banks" to get back to the absolute basic activities of the sector.
Mr Moulton also berated the ambition of the new business loan guarantee scheme, set to be unveiled by the Government today. He said: "Twenty billion pounds is not actually a very large number against the scale of the problems we're talking about.
"I would personally be happy if the scheme was a lot larger – it offends many of my basic principles, but we are in a bad hole and we need to get out of that hole."
Richard Lambert, the director general of the CBI, said the emphasis should now be on lending to larger companies. "Wholesale markets are frozen and I think there is particular reason to be concerned about the refinancing needs of larger companies who need a syndicate to take them through, and are finding it noticeably harder," he warned. "It's going to be appropriate for the taxpayer to take on more credit risk."
Mr Lambert, Mr Moulton and other witnesses urged the Government to "print money", while Mr Bernanke also spoke openly about the Fed's plans to implement a policy of "quantitative easing", though the Fed chairman prefers the term "credit easing".
The policy would not be inflationary, he said, because the "vast majority of banks are choosing to leave their excess reserves idle, in most cases on deposit with the Fed".
The Fed could "unwind" its positions relatively quickly, though the mortgage-backed securities would probably be retained for longer, he added.
The calls for action came amid further signs that the global economic slowdown is intensifying. In its annual global risk report, the World Econ-omic Forum, which is best known for its annual gathering in Davos, Switzerland, said that the international economy is threatened by Western governments' worsening public finances and a further collapse in asset prices as the financial crisis continues to take its toll.
The credit ratings agency Standard & Poor's yesterday issued a more pessimistic verdict on Portuguese sovereign debt, which joins Ireland, Spain and Greece in the euro-delinquents club, shaking confidence in the single currency.
The WEF added that China faced major difficulties, with growth set to drop below 6 per cent, a slowdown that would make global economic conditions much worse.