Fed Probing New Wall St. Credit Swaps

Federal Reserve Chairman Ben Bernanke told lawmakers Thursday that the central bank is looking into the use by Goldman Sachs and other Wall Street firms of high-risk financial instruments to make bets that Greece would default on its debt.

Bernanke said the Fed is examining companies' use of credit default swaps, a form of insurance against bond defaults. Bernanke made the comments at the start of a Senate Banking Committee hearing. It marked the second day where the Fed chief testified on Capitol Hill about the state of the economy.

"Obviously, using these instruments in a way that intentionally destabilizes a company or a country is counterproductive," Bernanke said, adding that the Securities and Exchange Commission probably will be looking into this matter as well.

"We'll certainly be evaluating what we can learn from the activities of the holding companies that we supervise here in the U.S," Bernanke said.

The panel's chairman, Sen. Christopher Dodd, D-Conn., said he is troubled that this practice could worsen Greece's debt crisis.

"We have a situation in which major financial institutions are amplifying a public crisis for what would appear to be for private gain," Dodd said.

Dodd wondered whether there ought to be limits on the use of credit default swaps to prevent "the intentional creation of runs against governments."

On another topic, Bernanke said that the snowstorms and bad weather that have recently affected the country will likely have a short-term — but not permanent — impact on unemployment and layoffs. He said policymakers will "have to be careful about not overinterpreting" upcoming data.

Even though the economy is growing once again, senators on both side of the aisle worried about high unemployment — now at 9.7 percent — rising home foreclosures and difficulties people and businesses have in getting loans.

"The state of our economy as a whole may be improving, but if we're talking about the situation of ordinary American families, I think I can sum up this recovery in three words: not good enough," Dodd said.

Senators pressed Bernanke for ideas about what Congress can do to help out, especially in bringing down unemployment. The Senate on Wednesday approved a package aimed at generating jobs by giving companies a tax break for hiring the unemployed.

Bernanke shied away from providing recommendations but did say that if additional stimulus measures are approved, it would be "very constructive" to pair them with a plan on how the government intends to lower record-high deficits down the road.

On the economy, Bernanke repeated the message he delivered Wednesday to the House Financial Services Committee: that record low interest rates are still needed to make sure that the budding economic recovery is lasting and to help relieve high unemployment.

And, Bernanke again argued against Senate efforts to strip the Fed of its powers to regulate banks, saying such a move would be a "grave mistake."

Doing so, would deprive the Fed of information that factors into the setting of interest rates to influence overall economic activity, he said. Bernanke also argued that the Fed would lose insights into the health of not only individual banks but also of the entire banking system.

Dodd has wanted to rein in the Fed's power and remove it from overseeing banks as part of a broader legislative revamp of the nation's financial structure. That conflicts with the Obama administration's stance as well as the approach taken by House lawmakers in their financial overhaul bill.

On another subject, Bernanke said Congress needs to tackle the thorny issue of how to overhaul Fannie Mae and Freddie Mac, which were taken over by the government in 2008 as they faced mounting losses from mortgage defaults.

"Right now, we're kind of in no-man's land. Fannie and Freddie are in conservatorship. They are part of the government's efforts to maintain the housing market, because there really is no other source of mortgages at this point or mortgage securitization. But, certainly, this is not a sustainable situation," Bernanke said. An overhaul is needed to eliminate this "platypus kind of — you know, neither fish nor fowl status that those firms have now," he added.

Treasury Secretary Timothy Geithner said Wednesday that the Obama administration will wait until 2011 to propose a revamp of the mortgage companies.