Fed to look into insurance contracts on Greek debt

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. He made the comments at the start of a Senate Banking Committee hearing. It marked the second day that the Fed chief has testified on Capitol Hill about the economy.

Bernanke also:

• Said the severe snowstorms that recently affected the country will likely have a short-term effect on unemployment and layoffs. He said policymakers will "have to be careful about not overinterpreting" upcoming data.

• Argued anew against Senate efforts to strip the Fed of its powers to regulate banks, saying such a move would be a "grave mistake."

• Said Congress must 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.

• Repeated a message he delivered Wednesday to the House Financial Services Committee: that record-low interest rates are still needed to ensure the economic recovery lasts and to help relieve high unemployment.

On credit default swaps, Bernanke said, "Obviously, using these instruments in a way that intentionally destabilizes a company or a country is counterproductive. We'll certainly be evaluating what we can learn from the activities of the holding companies that we supervise here in the U.S."

The panel's chairman, Sen. Christopher Dodd, D-Conn., cited reports that financial companies are using credit default swaps to bet that Greece will default on its debt. He's 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 private gain," Dodd said.

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

Securities and Exchange Commission spokesman John Nester wouldn't say whether his agency is looking specifically into the credit default swap arrangements between Wall Street firms, including Goldman Sachs, and Greece.

"As an agency, we have been examining potential abuses and destabilizing effects related to the use of credit default swaps and other opaque financial products and practices," Nester said in a statement.

SEC Chairman Mary Schapiro has advocated bringing the financial instruments under government regulation.

Goldman Sachs earlier this week defended currency swap deals it undertook with Greece to reduce that country's debt, saying the impact of the transactions was minimal and within the rules.

Even though the economy is growing again, senators on both sides 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 he 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 shrink record-high deficits later.

The chairman argued that disarming the Fed of its authority to regulate banks would deprive it of information needed to set interest rates and influence economic activity. Bernanke also warned that the Fed would lose insights into the health of individual banks and 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 Fannie Mae and Freddie Mac, Bernanke said: "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."

He 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.

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AP Business Writer Marcy Gordon contributed to this report.

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