By Steven K. Beckner

CHICAGO (MNI) – Federal Reserve Chairman Ben Bernanke stressed
Thursday the need to restore a proper “balance” between making loans to
creditworthy borrowers and lending prudence.

While the pendulum had swung too far in the direction of
excessively risky loans before the financial crisis, it has now swung
too far in the other direction, Bernanke told the Federal Reserve Bank
of Chicago’s 46th Annual Conference on Bank Structure and Competition.

As a result, he said credit conditions for small business are the
tightest they have been in recent memory.

Bernanke, answering questions following a speech in which he called
the restoration of normal credit flows a “central objective” of the Fed,
also said he is working to discourage what he called “excessive
conservatism” among bank examiners.

Bernanke said the big issue facing banks and their regulators is
the need to restore a “balance between lending to creditworthy borrowers
and appropriate prudence.”

Before the crisis, he said “the balance shifted to imprudent
lending.” Now, he said, “we need a more appropriate level” of lending
“that takes an appropriate balance between making good loans and being
appropriately prudent.”

He said bank credit should be “less easy than before the crisis,”
but said “surveys suggest conditions for small business borrowers have
tightened considerably because of bank caution.”

“Business conditions for borrowers have worsened as well,” he
added. “Right now small business conditions are much tighter than
anytime in recent memory,” he said. “We need to find a balance that
makes economic sense.”

Banks should be “making good loans that are expected to be repaid,”
but should “not be so conservative and restrictive that they turn away”
borrowers who can “be expected to be creditworthy.”

Similarly, Bernanke inveighed against “excessive conservatism” by
examiners that he said could mean banks will not lend to creditworthy
customers. “That is not appropriate,” he said.

Bernanke stressed is was “not talking about forbearance” but about
“an appropriate balance.” Bank examiners should “not overreact to the
point that good solid borrowers can’t get credit.”

Regarding commercial real estate loans and commercial
mortgage-backed securities, Bernanke said both “remain a problem.”

“It’s been a tough situation both because … banks are reluctant
to make loans” and because “the CMBS market has been pretty moribund.”
Commercial real estate “remains a significant concern as we look at the
health of medium and smaller sized banks,” he said.

Bernanke said there are “some slivers of light on the horizon,”
such as “some improvement in funding levels, stabilization of prices in
commercial real estate” and “some improvements in the economy.”

He cited increased occupancy rates and said “we are seeing some
improvements in the financing side as well.”

He said the Fed’s Term Asset-Backed Securities Loan Facility has
“helped” by supporting older “legacy” and new CMBS issuance.

But while there is “a little bit of a silver lining,” commercial
real estate “remains a very troubled category of loans … We’re going
to have to keep working with banks.”

In other comments, Bernanke said government-sponsored enterprises,
like Fannie Mae and Freddie Mac, need to be reformed.

“Clearly the (pre-crisis) model of Fannie Mae and Freddie Mac is
not a sustainable model,” he said, adding that those quasi-private firms
were “insufficiently capitalized” and had a “conflict between public and
private objectives.”

As he has before, Bernanke suggested two possibilities:

1. “to acknowledge that Fannie Mae and Freddie Mac are government
utilities and make them wholly public … Make them honest … doing
what their politically determined objectives are”

2. “to privatize Fannie Mae and Freddie Mac and break them up” and
“allow them to compete in the market for securitization along with other
firms”

Bernanke said the second option has an “attraction.”

If the GSEs are privatized, he said Congress should “consider
whether the government needs to be a deep backstop where mortgage
markets break down. … You might consider a case where the privatized
firms, the GSEs and other financial firms could pay a premium to the
government and get insurance.”

He said that would “allow these institutions to stand by their
mortgage backed securities similar to the way Fannie and Freddie did in
the past and allow the securitization market to continue to function
even in periods of great financial stress.”

“What we had before was a wink and a nod,” Bernanke said. “The GSEs
had implicit (government) support but not explicit support, and they
didn’t pay for that support, and their capital was not adequate.”

GSE reform needs to be “straightforward,” he said. “We need to
design those institutions in a way to achieve those (housing finance)
objectives” without having “conflicts of interest.”

Bernanke said he expects “securitization will come back but in a
more secure, better structured way.”

** Market News International Washington Bureau: 202-371-2121 **

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