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Bernanke Tries To Calm Doubts About Bailout Plan

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The Associated Press

Published: September 24, 2008

Updated: 09/24/2008 12:51 pm

WASHINGTON - Federal Reserve Chairman Ben Bernanke said Wednesday that the worsening financial crisis could prove a major weight on U.S. business growth and pledged to "act as needed" to brace the wobbly economy.

Bernanke and his Fed associates are fighting the biggest financial debacle since the Great Depression. On Wednesday, the Fed chief faced a second straight day of tough questioning on Capitol Hill about the Bush administration's proposed $700 billion bailout plan.

Lawmakers have voiced skepticism about the plan aimed at shoring up troubled financial institutions and markets.

"Americans are furious," said Sen. Chuck Schumer, D-N.Y., chairman of Congress' Joint Economic Committee. Lawmakers were hearing "amazement, astonishment and intense anger" from their constituents, he said. Yet, he said he still believes some agreement on a bailout would soon be reached.

Bernanke has been trying to reassure the country that the Fed will do what it can to provide relief. Some analysts think interest rates might be lowered again soon.

The Fed chief appeared much more concerned about the stumbling economy right now than about the prospects of inflation getting out of control. The slowing economy should cause inflation to moderate later this year and next, he said.

In testimony to the Joint Economic Committee, Bernanke repeated his warning of dire economic consequences if the bailout isn't enacted and if credit woes persist. Neither businesses nor consumers would be able to borrow money, he said, adding that such a scenario could result in the world's largest economy grinding to a virtual halt.

"The intensification of financial stress in recent weeks, which will make lenders still more cautious about extending credit to households and business, could prove a significant drag on growth," Bernanke said. "The downside risks to the outlook thus remain a significant concern."

All told, the economy is likely to turn in a subpar performance in the second half of this year, Bernanke said. Consumers are expected to rein in their spending as unemployment rises, paychecks shrink and the energizing impact of the government's tax rebates disappears. Slowdowns overseas aren't helping, Bernanke said, noting that they'll cause American export growth to recede.

"Economic activity appears to have decelerated broadly," Bernanke said.

If credit stresses drag on, he warned lawmakers Tuesday, the economy could actually shrink, more jobs will be lost and foreclosures - already at record highs - will rise even more.

"Choking up of credit is like taking the lifeblood away from the economy," Bernanke said. Asked whether the country would plunge into a depression if Congress didn't act, Bernanke said he didn't want to make such a comparison but said there would be "certainly very negative implications," including likely losses on retirement funds and other investments held by millions of ordinary Americans.

Although Bernanke welcomed the recent retreat in oil prices from the all-time high of $147.27 a barrel reached in mid July, he said the central bank must remain vigilant because the situation can turn quickly. Oil prices are up about $15 in the past week. Such fluctuations in oil prices in the past few days illustrate the difficulty of predicting the future course of prices, Bernanke said.

Last week, the Fed decided to hold its key interest rate steady at 2 percent for the third straight meeting. However, it struck a more bearish tone on the economy, hinting that rates could go lower if conditions seriously deteriorate. Earlier this year, the Fed had halted its most aggressive rate-cutting campaign in decades out of fear that the low rates were aggravating inflation. Financial turmoil, however, has now overwhelmed those concerns.

"Stabilization of our financial system is an essential precondition for economic recovery," Bernanke told lawmakers on Wednesday.

To that end, the Fed chief urged Congress to act quickly on the administration's bailout plan, which he said he doesn't believe will worsen inflation.

The administration's plan would allow the government to buy bad mortgages and other rotten assets held by troubled banks and financial institutions. Getting those debts off their books should bolster those companies' balance sheets, making them more inclined to lend and easing one of the biggest choke points in the credit crisis. If the plan works, it should help lift a major weight off a national economy already crumbling under the burden of instability.

However, both Democrats and Republicans said that big changes are needed in the bailout plan. And that presages a difficult road ahead for the measure on Capitol Hill, with the election-year break bearing down on lawmakers.

"The vultures have come home to roost. I think we need to look very critically at this bailout," said Rep. Lloyd Doggett, D-Texas.

A thorny issue is how to price the distressed assets the government would buy.

Bernanke said he thinks prices will probably be higher than rock-bottom, or fire-sale, but added: "I am not advocating the government intentionally over pay" for the assets.

So far this year, a dozen federally insured banks and thrifts have failed, compared with three last year. The country's largest thrift, Washington Mutual Inc., is faltering.

The U.S. has taken extraordinary measures in recent weeks to prevent a financial calamity, which would have devastating implications for the broader economy. It has, among other things, taken control of mortgage giants Fannie Mae and Freddie Mac, provided an $85 billion emergency loan to insurance colossus American International Group Inc. and temporarily banned short selling of hundreds of financial stocks.

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