Behind Dow's rebound, Bernanke's straight talk

Finally, a federal official offered some specifics about what Washington plans to do with large troubled banks – and on hearing it, Wall Street soared Tuesday.

Never mind that the stock market was due for a bounce anyway after Monday's plunge. Never mind that the official, Federal Reserve Chairman Ben Bernanke was talking more about Treasury's plan than his own. His testimony before the Senate Banking Committee helped to fuel the market rally by describing an uncertain but plausible path toward recovery.

The Dow Jones Industrial Average climbed 236 points to close at 7350.94, a 3.3 percent jump that recovered nearly all its loss from Monday. The S&P 500 jumped 4.0 percent to 773.14 and the Nasdaq climbed 3.9 percent.Mr. Bernanke's remarks cheered investors because at times he stripped out all the usual caveats that central bankers employ and talked turkey about the state of the troubled banks, which lie at the heart of the economic crisis facing the United States.

Pressed by Corker

The most illuminating part came after nearly four hours of testimony when many of the senators had already left. Sen. Bob Corker (R) of Tennessee got the ball rolling by asking about using federal money to boost the reserves of troubled banks.

Senator Corker: "What you're going to do is actually to get them to increase those reserves substantially. At that point they'll be insolvent and so therefore then you'd be providing public funding to make up that capital deficiency. Is that correct?"

Bernanke: "I don't agree necessarily that they'll be insolvent. Clearly, we have to look at their provisioning" of reserves.

Corker: "Their capital will be too low so they might not be insolvent. But the fact is they would need in some cases substantial public investment so they would be considered solvent."

Bernanke: "So they would be considered well-capitalized."

Corker: "We're going to go in and create this mechanism – these convertible preferred shares – and as the banks actually take these losses, which we know are coming, they'll convert that into common equity. But in essence, we're sort of continuing what we have been doing with TARP funding. We're just calling it something a little different."

Bernanke: "There will be some public ownership in terms of the shares of common equity. We want them to have enough capital."

Corker: "It seems to me that what you have explained is a creeping nationalism of our banks."

Bernanke: "Senator, there are two sides to this. One side is providing the capital, which they need to have in order to provide credit to the economy, which is essential. But we're not just handing them this capital saying 'Go do your thing.' We also have on the other side a supervisory oversight, the TARP oversight, to make sure that they are not just sitting around but that they are taking the steps necessary to clean themselves up, get themselves straightened out, so that they will be profitable in the future. At that point, private capital will come in and public capital can go out. And as I was saying before, the best sign of success will be when the government can start taking its capital out or the banks can start replacing the public capital with private-sector capital. That's what we're aiming for."

You could almost hear the sigh of relief from Wall Street. "Nationalism" would be temporary and give way to private reinvestment.

Shelby joins in

The proceedings weren't quite done.

Sen. Richard Shelby (R) of Alabama: "Aren't you sending a message out that you're going to keep these banks open, no matter what? And if you are, how are you ever going to attract private capital? ... They're not investing in the banks because they don't trust the banks?"

Bernanke: "The first step ... is to get the clarity.... And there's two parts to this program that are going to do that. The first is the assessment that we're undertaking [with the stress test of banks]. And the second is what happens after the asset-purchase program goes into place and takes assets off their balance sheets."

More Bernanke: "If I thought the banks were irrevocably damaged, I would have a different view, but I do believe that our major banks have significant franchise values. And one of the things that we've learned is that when the government takes over a company that one of the things that happens immediately is that the counterparties start pulling away, the franchise value, the brand name starts to erode very quickly. So, I think, if we can through our regulatory process, we can get the banks to perform better and to improve.... The time may come when, if they don't succeed in doing that, it will be appropriate to shut them down and so on. But for the moment, I think the right strategy is transparency – find out what we can about their true status – and to try to find the minimally disruptive way to get them into an improved position. And I think those things are feasible right now."

It was one of those rare moments of unvarnished talk from a central banker. Forceful. Restrained. Realistic, and with a dash of optimism in the face of deepening economic pessimism. (How can America break the gloom? Click here.)

The markets – maybe all of America – could use more such talk.