Bernanke warns debt threatens recovery

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By Patrice Hill

Federal Reserve Chairman Ben S. Bernanke warned Wednesday that out-of-control deficits are helping to drive up interest rates on mortgages and Treasury bonds in a threat to the budding economic recovery.

A sharp increase in mortgage rates recently has snuffed out the refinancing boom and could shatter the fragile stability emerging in the beleaguered housing market. The stricken auto sector also is heavily dependent on low interest rates to stage a recovery.

While acknowledging that part of the quadrupling of the deficit to a record $1.85 trillion this year reflects efforts to ease the recession, Mr. Bernanke said the rise in rates is signaling mounting anxiety among investors that Congress and the administration have offered far more plans to increase spending than to lower it.

"Maintaining the confidence of the financial markets requires that we, as a nation, start planning now for the restoration of fiscal balance," he said in testimony before the House Budget Committee.

The Fed chairman stressed that investors are troubled by the projected increase in the national debt within two years to 70 percent of economic output from 40 percent today under President Obama's budget plan -- the highest since the aftermath of World War II -- with little indication the debt won't keep rising unsustainably after that as Congress piles on plans for massive new spending on health care, energy and other areas.

Moreover, these worrisome increases in the debt are occurring just as the retirement of baby boomers commences, which will inexorably drive the deficit higher for decades to come, he said.

"We will have neither financial stability nor healthy economic growth" unless Congress and the administration take steps now to address the imbalances in Social Security and Medicare and "demonstrate a strong commitment to fiscal sustainability in the longer term," he said.

Mr. Bernanke's testimony highlighted how the burgeoning deficits are creating problems for the Fed as it tries to spur an economic recovery. The Fed has been purchasing Fannie Mae bonds since the beginning of the year in an effort to drive mortgage rates lower.

The Fed's campaign early this year caused a big drop in 30-year mortgage rates to about 4.5 percent, spawning a major refinancing boom that was helping consumers refinance out of troublesome mortgages and increase their disposable income.

But a jump in mortgage rates last week from 4.81 percent to 5.25 percent signaled an end to the refinancing trend, with refinancing applications plunging 24 percent from the previous week, the Mortgage Bankers Association reported Wednesday.

The sharp rise in mortgage rates lags behind the even bigger jump in rates on long-term Treasury bonds, which have increased a full percentage point since March. While gigantic deficits are helping spur the rise in rates, Mr. Bernanke noted that greater optimism about an economic recovery also has played a role, as well as a reversal of the flight to safe-haven Treasury bonds seen among investors last winter amid the financial crisis.

Rep. Paul D. Ryan of Wisconsin, ranking committee Republican, said the rising bond yields were "telling us that there is no free lunch," and he cautioned that the combination of huge Treasury debt issuance and central bank purchases of Treasury bonds under a recently announced Fed program could be a dangerous mix.

"The Treasury is issuing debt and the central bank is buying it," Mr. Ryan said. "It gives the alarming impression that the U.S. one day might begin to meet its financial obligations by simply printing money."

But Mr. Bernanke adamantly denied that would happen. "The Federal Reserve will not monetize the debt,"he said. "Either cuts in spending or increases in taxes will be necessary to stabilize the fiscal situation."