Bernanke: Recession possible, growth to rebound

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Federal Reserve Chairman
Ben Bernanke on Wednesday conceded for the first time the U.S. economy
may slip into recession, but said growth should pick up later this year as the
impact of interest rate cuts and other emergency steps take root.

Bernanke told a
congressional panel that the economy appeared to be growing, but warned it
could shrink in the first half of 2008. It was Bernanke’s first testimony on
Capitol Hill since the U.S.
central bank helped rescue investment bank Bear Stearns in mid-March, an action
he defended as averting a collapse that would have been calamitous.

“Recession is
possible,” Bernanke told the Joint Economic Committee. “Our estimates
are that we are slightly growing at the moment, but we think that there’s a
chance that for the first half as a whole, there might be a slight
contraction.”

The Fed has lowered
benchmark interest rates by three percentage points to 2.25% since
mid-September to help put a floor under an economy hit hard by a housing slump
and credit market turmoil.

Bernanke said those rate
cuts and other emergency measures to thaw frozen credit markets should promote
growth over time — remarks traders in financial markets saw as a signal that
the Fed’s sharp rate-cutting action may be drawing to an end.

Some analysts said the
absence of a specific pledge by Bernanke to act as needed to help the economy,
a standard feature of recent Fed statements, buttressed that view. “There
is a conspicuous absence of policy commitment in this statement,” said Jan
Hatzius, chief economist at Goldman Sachs.

U.S. stock prices slipped, with the blue chip Dow Jones
industrial average closing down 48.53 points at 12,605.83. Prices for U.S. government
bonds also fell, as did the value of the dollar.

 

DEFENDS BEAR STEARNS RESCUE

 

Bernanke defended the Fed’s
role in providing emergency funding to prevent an abrupt bankruptcy at Bear
Stearns, which had been the fifth largest U.S. investment bank, which he said
could have caused a “chaotic” market reaction.

The Fed, informed on March
13 that Bear Stearns was on the verge of collapse, decided to provide a $30 bln
credit line backed by the firm’s shaky assets to facilitate its purchase by
JPMorgan Chase. The action raised questions about the central bank’s
willingness to shield investors from risks.

“Our financial system
is extremely complex and interconnected, and Bear Stearns participated
extensively in a range of critical markets,” Bernanke said.

“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.

If financial markets had
been in more solid condition, policy-makers may have held back, but decided
under current conditions that it was too risky to allow the firm to fail
unexpectedly, Bernanke said.

“That was an
extraordinary thing to do,” he said. “I thought about it long and
hard. I would hope not to ever do it again.”

 

MARKETS REMAIN STRESSED

 

Bernanke said financial
markets remain under considerable strain but that emergency measures to provide
liquid funds have been helpful in alleviating some of the stresses. Funding
pressures on large financial institutions seem to have eased somewhat, and some
markets, including the market for mortgage-backed securities, appear to be more
liquid, he said.

“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. “I remain
confident in our economy’s long-term prospects.”

He said the Fed expects the
economy to strengthen in the second half of the year, and for growth to proceed
at or a little above its sustainable pace in 2009.

Bernanke, however, said
uncertainty surrounding the outlook was “quite high” and that there
was a risk the Fed’s forecast would prove too optimistic. He also said
inflation was a concern, although price gains should moderate.

Bernanke said a Treasury
Department proposal to overhaul financial regulation, which would give the Fed
responsibility for overall financial market stability but remove it from
front-line bank examination duties, could hurt the Fed’s ability to keep tabs
on the health of the financial system.

“We could not
successfully carry out this mission if we had to rely entirely on second hand
reports from primary supervisors of these individual institutions,” he
said.