Bernanke on Municipal Bond Bailout: No Way

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Federal Reserve Bank Chairman Ben Bernanke

On Friday, Federal Reserve Chairman Ben Bernanke dismissed the possibility that the central bank would intervene in the municipal credit markets.

In testimony before the Senate Budget Committee Bernanke said: "We have no expectation or intention to get involved in state and local finance." He later said that states "should not expect loans from the Fed."

The comes according to a story in Friday's Wall Street Journal.

According to the Journal, the rationale for the policy of nonintervention is the following:

"The Fed only has legal authority to buy muni debt with maturities of six months or less that is directly backed by tax or other assured revenue, which makes up less than 2% of the overall market. The Dodd-Frank financial-regulation law enacted last year further tied the Fed's hands, Mr. Bernanke noted, by barring the central bank from lending to insolvent borrowers or pursuing bailouts of individual borrowers."

It seems only reasonable to begin the inevitable speculation about Bernanke's motivation for making those statements at this time.

Perhaps the most likely reason for the Chairman statements before Congress is a desire to preclude a moral hazard situation—to make clear to the states that the Fed is not waiting in the wings with an enormous bailout package in the event that their financial situation continues to deteriorate.

Bernanke also sought to placate lawmakers on the looming threat of a meltdown in Muni-land.

Again, from the Journal:

"Mr. Bernanke played down the risk of a major municipal-bond crisis, noting that muni markets have been functioning normally, with healthy trading volumes and lots of issuance. But he said that if municipal defaults did become a problem, it would be in Congress's hands, not his."

Nonetheless, Bernanke's assertions of an inability to intervene - even in the event that such intervention seems necessary to prevent a fiscal meltdown at the state level- seem eerily reminiscent of the plaintive comments of another high-ranking government official.

I'm of course referring to former US Treasury Secretary Hank Paulson.

In October of 2008, following closely upon Lehman Brothers September 15, 2008 bankruptcy filing, Secretary Paulson said in an interview "If someone thinks Hank Paulson could have made the Fed save Lehman Brothers, the answer is 'no way',"

It at least seems reasonable to wonder if Chairman Bernanke's statement is intended as an opportunity to preemptively go on record before Congress on the issue. Are his statements intended to explain the limited statutory scope of the powers of the Chairman of the Fed— and, perhaps, an attempt to manage expectations in the event of a major crisis in the municipal debt markets?

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