Bernanke: Bailout shouldn’t be done at ‘fire-sale’ prices

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The government’s plan to buy $700 billion in bad mortgage assets from banks shouldn’t be done at ‘fire-sale’ prices that could push the financial system deeper into a hole, Federal Reserve Chairman Ben S. Bernanke told Congress today.

Testifying before the Senate Banking Committee, Bernanke addressed one of the critical issues of the bailout plan: What price to pay banks and other financial institutions for the troubled assets they are desperate to unload.

Purchases should be made close to ‘hold-to-maturity’ prices, the Fed chief said -- meaning, prices that reasonably reflect how much of a loan is likely to be repaid in time, as opposed to a price that reflects only the current panic to dump the assets.

The question is whether that strategy would result in the government overpaying the banks, ultimately costing taxpayers more money.

Here’s what Bernanke said, according to a Reuters transcript:

‘Let me come to the critical point: I believe that under the Treasury program, auctions and other mechanisms could be devised that will give the market good information on what the hold-to-maturity price is for a large class of mortgage-related assets. If the Treasury bids for and then buys assets at a price close to the hold-to-maturity price, there will be substantial benefits.

‘First, banks will have a basis for valuing those assets and will not have to use fire-sale prices. Their capital will not be unreasonably marked down.

‘Second, liquidity should begin to come back to these markets.

‘Third, removal of these assets from balance sheets and better information on value should reduce uncertainty and allow the banks to attract new private capital.

‘Fourth, credit markets should start to unfreeze. New credit will become available to support our economy.

‘And fifth, taxpayers should own assets at prices close to the hold-to-maturity values, which minimizes their risk.

‘To make this work, we do need flexibility in design of mechanisms for buying assets and from whom to buy. We do not know exactly what the best design is. That will require consultation with experts and experience with alternative approaches.

‘Second, understanding the concerns and the worries of the committee, we cannot impose punitive measures on the institutions that chose to sell assets. That would eliminate or strongly reduce the participation and cause the program to fail.

‘Remember the beneficiaries of this program are not just those who sell the assets, but all market participants in the economy as a whole.’