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.
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.
New York Fed President William C. Dudley, who is also vice- chairman of the FOMC, said this week the world’s largest economy still faces challenges.
“The incoming data on the U.S. economy has been a bit more upbeat of late, suggesting that the recovery may be getting better established,” Dudley said in a March 19 speech. “But, while these developments are certainly encouraging, it is far too soon to conclude that we are out of the woods in terms of generating a strong, sustainable recovery.”
European markets have stabilized on speculation that government leaders are containing the region’s debt crisis. The Stoxx Europe 600 Index has rallied 25 percent since Sept. 22, when it closed at a two-year low. The rate that London-based banks say they pay for three-month loans in dollars was 0.474 percent yesterday. Libor, a gauge of banks’ reluctance to lend, is down from a 30-month high of 0.583 on Jan 3.
Bernanke said that the calming of Europe’s crisis has led to “an improved tone of financial markets around the world.”
The 58-year-old Fed chairman said that most of the largest U.S. banks could maintain adequate capital in the event of a sharp downturn in Europe and a new recession in the U.S., referring to a round of so-called stress tests completed last week.
Fifteen of 19 banks would be able to maintain capital levels above a regulatory minimum in an “extremely adverse” economic scenario, even while continuing to pay dividends and repurchasing stock, the Fed said last week.