Bernanke says Europe must aid banks even as strains eased

March 21 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said Europe must further strengthen its banks and that its financial and economic situation “remains difficult” even as stresses have lessened, according to testimony today to U.S. lawmakers.

“Full resolution of the crisis will require a further strengthening of the European banking system,” Bernanke said in testimony to the House Committee on Oversight and Government Reform. The region’s leaders also must “increase economic growth and competitiveness and to reduce external imbalances in the troubled countries,” he said.

Bernanke said reduced stress is a “welcome development” for the U.S., which echoed the Federal Open Market Committee’s statement last week that “strains in global financial markets have eased, though they continue to pose significant downside risks to the economic outlook.”

U.S. banks “have limited exposure to peripheral European countries” such as Greece and Portugal. Their exposure “to the larger, ‘core’ countries of Europe are more material,” Bernanke said.

“Moreover, European holdings represented 35 percent of the assets of prime U.S. money market funds in February, and these funds remain structurally vulnerable despite some constructive steps,” he said.

‘Not Considering’

The Fed is “not considering” purchasing any of Europe’s sovereign debt as the purpose of the central bank’s authority to buy such debt is only to maintain foreign exchange reserves, Bernanke said in response to questions from lawmakers.

He also said the Fed has reviewed the credit-default swaps, contracts that U.S. banks have used to insure against defaults in Europe, and that they are “widely dispersed.” The central bank does not expect a repeat of 2008, when American International Group Inc., a large counterparty on swaps, collapsed, Bernanke said.

AIG is “an example of what we don’t see now,” he said.

Recent economic reports have shown strength in the U.S. economy as the threat from Europe has eased. The Commerce Department reported yesterday that builders broke ground on 698,000 homes at an annual rate in February, close to a three- year high. Building permits, a proxy for future construction, rose to the highest level since October 2008.

The Standard & Poor’s 500 Index, which has risen 12 percent this year, declined 0.2 percent to 1,402.92 at 10:56 a.m. in New York. The yield on the 10-year Treasury note fell to 2.32 percent from 2.36 percent yesterday.

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