Federal Reserve chairman Ben Bernanke said there are some signs that credit markets are improving, but that conditions are "still far from normal" and it is "critical" to market confidence that TARP funds are injected into financial firms.

"The ongoing capital injections under the TARP are continuing to bring stability to the banking system and have reduced some of the pressure on banks to deleverage, two critical first steps toward restarting flows of new credit," the Fed chairman said.

Testifying before the House Financial Services Committee on Tuesday, Bernanke said banks should review compensation to curb risk taking, and that they should set appropriate dividend policies.

"Steps that should be taken in this area include ensuring adequate funding and staffing of mortgage servicing operations and adopting systematic, proactive, and streamlined mortgage loan modification protocols aimed at providing long-term sustainability for borrowers," he said. "Finally, the agencies expect banking organizations to conduct regular reviews of their management compensation policies to ensure that they encourage prudent lending and discourage excessive risk-taking."

Bernanke didn't speak on the broader outlook for the U.S. economy in his prepared remarks.

Also testifying was Sheila Bair, head of the FDIC, who said a major acceleration in loan modifications is essential to stem foreclosures. She said the stakes are too high to rely exclusively on industry commitments, so she is seeking support for a mortgage-guarantee plan.

Bair, ranked the second most powerful woman in the world by Forbes Magazine, has been pushing hard recently for a plan to aid homeowners at risk of foreclosure. Many believe she could have a senior role in the incoming Obama administration, possibly even Treasury Secretary.

By Patrick McGee and edited by Sarah Sussman
©CEP News Ltd. 2008