As financial conditions improve, the Federal Reserve will start using agency MBS in reverse repurchase agreements to soak up excess reserves in the banking system and eventually start to sell MBS at a "gradual pace," according to Fed chairman Ben Bernanke.

"Any such sales would be at a gradual pace, would be clearly communicated to market participants, and would entail appropriate consideration of economic conditions," the Fed chief says in testimony prepared for a House Financial Services Committee hearing. Wednesday's hearing was canceled because of the snowstorm that has paralyzed Washington.

But the Fed issued the highly anticipated testimony to outline its plans for phasing out the liquidity programs the central bank employed to deal with the financial crisis and resulting credit crunch.

The Fed is slowing its agency MBS purchases now as it prepares to stop the program on March 31. The Fed is developing the infrastructure necessary to use its MBS holdings as collateral for reverse repo transactions, according to the testimony.

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