Bernanke Warns of Dire Risks in U.S. Yet Fed Chief Says 2010 Could Wind Up As 'Year of Recovery'

Source: International Herald Tribune)By Catherine Rampell and Jack Healy
As President Barack Obama prepared to make a major Congressional address laying out his plans to lift the faltering U.S. economy, the chairman of the Federal Reserve warned on Tuesday that the downturn could get even worse than recent economic forecasts.

Ben Bernanke, the Fed chief, told the Senate Banking Committee that the central bank was doing everything it could to unlock credit markets and ease the financial crisis. But he said it could take until 2010 before the government's actions gained traction.

"If actions taken by the administration, the Congress and the Federal Reserve are successful in restoring some measure of financial stability - and only if that is the case, in my view - there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery," Bernanke said.

Bernanke spoke as a pair of surveys released Tuesday underlined the grim condition of the American economy. U.S. consumer confidence and housing values plummeted. And major U.S. retailers, including Home Depot and Macy's, reported poor earnings.

In the first leg of Bernanke's twice-annual report to both houses of Congress on the state of the economy and the Fed's actions, he painted a dire picture of the financial markets going forward, but assured the committee that government agencies were taking all necessary actions to thaw credit markets.

"The measures taken by the Federal Reserve, other U.S. government entities, and foreign governments since September have helped to restore a degree of stability to some financial markets," Bernanke said. "Nevertheless, despite these favorable developments, significant stresses persist in many markets."

In particular, he said, most securitization markets - those in which investments are backed by a specific group of assets, like mortgages - "remain shut."

Wall Street was cheered by Bernanke's testimony, with the Dow Jones industrial average rising 2.7 percent in afternoon trading Tuesday a day after it slid to a 12-year low.

As required by law, Bernanke addressed both halves of the Fed's dual mandate: stable prices and maximum employment. The first part of the mission has largely been met, with prices more or less unchanged from their level a year ago, and inflation is expected to glide under 1 percent during 2009.

But labor market conditions continue to deteriorate. Citing projections by the interest-rate-setting Federal Open Market Committee in January, he said the unemployment rate, which soared to 7.6 percent in January, would probably reach 8.5 to 8.75 percent in the last quarter of 2009. The country's gross domestic product is projected to decline 0.5 to 1.25 percent this year, he said, and foreclosure rates remain at high levels.

But he added, "This outlook for economic activity is subject to considerable uncertainty, and I believe that, over all, the downside risks probably outweigh those on the upside."

A week ago, Obama laid out a $275 billion plan to help as many as nine million families refinance their mortgages or avoid foreclosures using a variety of incentives and subsidies to try to lower interest rates and the principal on existing home mortgages.

The Fed has taken some extraordinary steps in recent months in the hopes of increasing the flow of credit to businesses and households.

In December its Open Market Committee lowered its benchmark interest rate to virtually zero, its floor. The Fed has been buying mortgage-backed securities - considered the leading cause of the meltdown after the housing bubble burst - that have been guaranteed by the U.S. government. It has also begun unprecedented programs as a lender.

It has expanded the Term Auction Facility, which loans to banks. It has also introduced the Term Asset Backed Securities Loan Facility, which finances consumer loans, and which the Fed recently announced it would expand in both size and scope; and the Commercial Paper Funding Facility, which provides loans in exchange for commercial paper, or short-term business IOUs.

Bernanke said these actions had contributed to improvements in short-term financing markets and the commercial paper market, and declines in the conforming fixed mortgage rate and the London interbank offered rate, known as Libor, which is the rate on which borrowing costs for consumers and businesses are often based.

The Fed has also been working in partnership with the Treasury Department to coordinate intervention in the financial markets.

But the government's boldest rescue to date, its $150 billion commitment for the insurance giant American International Group, is foundering. AIG indicated on Monday it was now negotiating for tens of billions of dollars in additional assistance as losses have mounted.

Separately, the Obama administration confirmed it was in discussions to aid Citigroup, the recipient of $45 billion so far, that could raise the government's stake in the financial company to as much as 40 percent.

The Treasury Department also named a special adviser to work with General Motors and Chrysler, two of Detroit's biggest automakers, which are seeking $22 billion on top of the $17 billion already granted to them.

On Monday, the Treasury, the Fed and other bank regulatory agencies issued a joint statement announcing that the government might demand direct ownership in major banks after they undergo a "stress test" to determine their viability going forward.

Officials have also announced a plan to use public and private money to purchase so-called toxic assets from financial institutions, as well a measures to help slow the mass of foreclosures.

In his testimony Tuesday, Bernanke addressed criticisms regarding a lack of transparency in the administration of these and other programs. He discussed additional reports that the Fed has been providing to Congress, and a new Web site on the Fed's lending programs. He also noted that the Fed's vice chairman, Donald Kohn, is heading a committee to review the agency's publications and disclosure policies.

Meanwhile, the data released Tuesday by Standard & Poor's/Case- Shiller home price index revealed that U.S. home prices plunged at the fastest pace on record in December, a sign that housing was likely to continue declining in the months ahead as the economy sank deeper into recession.

Single-family home values in 20 major metropolitan areas fell 18.5 percent in December compared with a year earlier, the survey showed. Housing prices dropped 2.5 percent from November to December.

"It's a deflationary spiral," said Dan Greenhaus, an analyst in the equity strategy division of Miller Tabak.

And Americans' already battered confidence in the economy went into free fall in February, sinking to new lows as consumers grew more fearful over major job cuts and shrinking retirement accounts.

The Conference Board, a private research group, said Tuesday that its consumer confidence index, which fell slightly in January, plummeted more than 12 points in February to 25, from the revised 37.4 last month, and well below analysts' expectations.

The news came hours after major retailers, including Target, Home Depot and Macy's, reported depressed fourth-quarter results as shoppers focused more on necessities like food.