"In the past few months, financial stresses in Europe have lessened, which has contributed to an improved tone of financial markets around the world, including in the United States," Bernanke said in testimony prepared for a House hearing Wednesday.
Bernanke stresses, however, that a full resolution of the crisis "will require a further strengthening of the European banking system; a significant expansion of financial backstops, or “firewalls,” to guard against contagion in sovereign debt markets."
Bernanke also said that the exposure of US banks and money market funds to Europe remains a worry.
"Although U.S. banks have limited exposure to peripheral European countries, their exposures to European banks and 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, such as improved liquidity requirements, taken since the recent financial crisis."
Bernanke will also tell the House Committee on Oversight and Government Reform that European policymakers must follow through on fiscal reforms in order for the recent period of relative calm to persist.
The Fed chief reiterated the U.S. central bank's commitment to keeping the financial system stable, even if Europe's woes flare up again.
"The Federal Reserve will continue to monitor the situation closely, work with our financial institutions and foreign counterparts to enhance the resilience of our financial system, and be ready to use our tools to help stabilize U.S. markets should the situation require such action," said Bernanke.
In separate prepared testimony for the same hearing, Treasury Secretary Tim Geithner also addresses the threat of contagion: "The most important unfinished piece of the broader financial strategy is to build a stronger European firewall to provide a backstop for the governments undertaking reforms."
Geither brings attention to the fact that Europe’s leaders will establish another fund called the European Stabilization Mechanism (ESM) to succeed the European Financial Stability Facility (EFSF) starting in July 2012.
The ESM, says Geither, is crucial and must make clear to financial markets "that they have the financial resources available on a scale that is commensurate with future needs in the event the crisis were to intensify."
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