Bernanke Warns of Possible Recession

WASHINGTON (AP) – Federal Reserve Chairman Ben Bernanke said Wednesday a recession is possible and policymakers are “fighting against the wind” in trying to steady a shaky economy. He would not say if further interest rate cuts are planned.

Bernanke’s testimony before the Joint Economic Committee of Congress was a more pessimistic assessment of the economy’s immediate prospects than a report he delivered earlier this year. His appearance on Capitol Hill came amid a trio of economic slumps in the housing, credit and financial areas.

“It now appears likely that gross domestic product (GDP) will not grow much, if at all, over the first half of 2008 and could even contract slightly,” Bernanke told lawmakers. GDP measures the value of all goods and services produced within the United States and is the best barometer of the United States’ economic health. Under one rule, six straight months of declining GDP, would constitute a recession.

Federal Reserve Chairman Ben Bernanke testifies on Capitol Hill in Washington,
Wednesday, April 2, 2008, before the Joint Economic Committee.
(AP Photos/Susan Walsh)

Bernanke said “a recession is possible” but he also said he expects more economic growth in the second half of this year and into 2009, helped by the government’s $168 billion stimulus package of tax rebates for people and tax breaks for businesses as well as the Fed’s aggressive reductions to a key interest rate.

“Much necessary economic and financial adjustment has already taken place, and monetary and fiscal policies are in train that should support a return to growth in the second half of this year and next year,” Bernanke said.

To try to limit the damage, the Federal Reserve has aggressively cut a key interest rate, now at 2.25 percent, to spur buying and investing by individuals and businesses. At the Fed’s last meeting in March, however, two members dissented from the Fed’s decision to sharply cut rates, showing a rare division in the often unified front the Fed shows the public. The dissenting officials, who had reputations for being extra concerned about inflation, favored a smaller reduction. Although Bernanke said he hopes inflation will moderate in coming quarters, he acknowledged that high energy prices have clouded the inflation outlook.

Many economists had predicted the Fed might drop it key that rate again when it next meets April 29-30, although Bernanke’s remarks cast some doubt on that scenario.

“We are fighting against the wind,” Bernanke said. The Fed’s interest rate cuts and other actions are working their way through the economy and are having the effect of “at least offsetting significantly the headwinds coming from these financial factors,” he said.

On Wall Street, stocks initially dropped after the Fed chief’s remarks but later turned slightly positive.

Housing, credit and financial woes are threatening to push the country into a deep recession. The situation has emerged as a top concern for presidential contenders and a hot-button issue for Congress. It has thrust the White House and the Fed into crisis-management mode.

Faced with mounting home foreclosures and job losses, Bernanke has been under immense political and public pressure to provide relief and help turn around a faltering economy.

Committee Chairman Sen. Charles Schumer, D-N.Y., peppered Bernanke with questions about the Fed’s moves to aid once mighty Wall Street firm Bears Stearns and then juxtaposed that with what he believed was a lack of help to millions of people at risk of losing their homes.

“I hope that you will use your position to jawbone this administration to get behind the housing relief effort before Congress.” Schumer said. “Addressing the housing crisis head-on will do as much to instill confidence in the markets as lowering interest rates or bolstering regulatory oversight of wayward mortgage lenders and financial institutions. We need to do all of it.”

Sen. John Sununu, R-N.H., countered that government is taking steps to help. “The suggestion that the Fed’s taken action but nothing else has been done I think is a little bit misleading,” he said.

Bernanke urged Congress to take steps to help bolster the sickly housing market – a major source of economic stress – and to aid homeowners in danger of losing their homes.

Many private analysts believe the economy contracted in the first three months of this year, signaling the start of a recession. The government releases first-quarter results later this month. The economy lost jobs in January and February, with many economists bracing for more losses when the report for March is released on Friday. Bernanke said he expected unemployment to move “somewhat higher in coming months.”

“Clearly, the U.S. economy is going through a very difficult period,” he told lawmakers, adding that all the problems have weighed heavily on consumers whose spending is indispensable to economic vitality.

The Fed also has taken a series of extraordinary steps in recent weeks and months to prop up the nation’s financial system, which has been in a state of high jeopardy.

In a controversial move, the Fed backed a $29 billion lifeline as part of JP Morgan’s deal to take over the troubled Bear Stearns, the nation’s fifth largest investment house, which was on the brink of bankruptcy. Bear Stearns had invested heavily in risky mortgage-backed securities that eventually soured with the collapse of the housing market.

Bernanke defended the move. “With financial conditions fragile, the sudden failure of Bear Stearns likely would have led to a chaotic unwinding of positions in those markets and could have severely shaken confidence,” he said. “The damage caused by a default by Bear Stearns could have been severe and extremely difficult to contain.”

Although the taxpayers are on the hook for the $29 billion, Bernanke said he was “reasonably confident we’ll be able to recover the full amount.” He also said that Bear Stearns’ investments that the Fed took control of “are entirely investment grade.”

The Fed’s unprecedented involvement was meant as a one-time event, Bernanke said. “It has never happened before, and I hope it never happens again.”

In addition, the Fed – in the broadest use of its credit authority since the 1930s – agreed to temporarily let big investment firms obtain emergency financing from the Fed, a privilege that previously had been granted only to commercial banks.

Those actions have prompted criticism from Democrats and others who contend that the Fed is bailing out Wall Street and putting billions of taxpayers’ dollars at potential risk. Bernanke and the Bush administration argued that the actions were warranted to avert a potential meltdown in the entire financial system, something that would have devastating consequences for the overall economy.

Asked about the Bush administration’s plan to revamp the country’s creaky financial system, Bernanke said it was vital for the Fed to have sufficient enforcement powers. Under the plan, the Fed would become a top cop in charge of financial market stability but would lose its day-to-day supervision of U.S. banks.

Apr 2, 1:31 PM (ET)

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