Federal Reserve Chairman Ben S. Bernanke said yesterday that the economy may be in a mild recession, and he defended the Fed”s rescue of Bear, Stearns & Co. as a one-time move needed to keep the economy from worsening.
In testimony before the Joint Economic Committee, Mr. Bernanke was far more frank than his predecessors in acknowledging what most private economists have concluded: that an economic contraction likely started around the turn of the year and will continue through at least June before the economy starts growing again, in what by historic standards would be a short downturn.
“A recession is possible,” he said. The economy “will not grow much, if at all, over the first half of 2008 and could even contract slightly.” But he held out hope that the worst of the downturn — particularly the turmoil in the housing and financial markets — is over.
“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,” he said.
Signs of recession have piled up recently, including plunging auto sales, a deepening credit crisis and recession in housing that has ushered in a contraction in manufacturing and commercial real estate, and big drops in consumer confidence and spending.
Mr. Bernanke said the financial and economic distress has particularly taken a toll on consumers, who not only are facing a deteriorating job outlook and dismal housing market, but have to contend with record high prices for food and fuel. He said those soaring costs are largely outside the Fed”s control because they originate from forces overseas.
“That”s the most difficult problem for us, is to deal with those kinds of shocks,” he said.
Committee members prodded him for advice on what to do to aid the economy, but he said there are no quick fixes that either the Fed or Congress can enact to make the recession go away or to totally alleviate the burden on consumers. The Fed”s already deep interest rate cuts in January and February take time to work on the economy — usually six months to a year.
He recommended that Congress allow the $168 billion stimulus package with consumer tax rebates enacted in February to take effect this summer and wait until next year before considering whether more measures are needed to revive the economy.
Congress can take constructive steps, he said, by addressing and alleviating the housing crisis and by encouraging research into alternative fuels aimed at eventually replacing the nation”s overwhelming dependence on costly imported oil. Meanwhile, he said, consumers and lawmakers alike will simply have to persevere.
“We’re in a period where we”re having to deal with high energy costs while hoping and waiting for alternatives to come available,” he said.
On the Fed’s arranged buyout of Bear Stearns by J.P. Morgan, Mr. Bernanke said the central bank laid down strict terms to ensure that taxpayers lose little if any money in the $30 billion financing it provided on the deal. The Fed received mortgage holdings of dubious value in exchange for the loan, and expects it will be able to resell the mortgages over time to recoup the taxpayers’ expense, he said.
“We did not bail out Bear Stearns,” he said with some emotion, noting that “shareholders took a very significant loss, many employees will lose their jobs.”
“We did this for the economy. Everyone needs a healthy functioning financial system,” he said. “That was the reason for the action — not to help individual Wall Street people.”
Mr. Bernanke said the Fed was given only 24 hours” notice, with Bear Stearns informing it on March 13 that the company was about to go bankrupt. The $17 billion cash cushion the firm had reported to the Securities and Exchange Commission on March 11 had evaporated in only two days as creditors lost confidence in the firm and demanded payment on claims.
The Fed had to act quickly to prevent a potentially “chaotic unwinding” of “thousands” of credit derivative contracts the Wall Street giant had with other financial companies around the world, Mr. Bernanke said.
“The markets are very fragile,” he said. “In the current environment, we thought it was too risky to let this happen. … The adverse effects would not have been confined to the financial system but would have had an effect on asset values and would have been felt throughout the economy.”
He sought to assure Congress that the Fed does not foresee any more taxpayer-backed bailouts for Wall Street firms. Some other investment houses, including Lehman Brothers, Morgan Stanley and Citigroup, have encountered some of the same extreme pressures in credit markets that brought Bear Stearns down.
“I do not expect a repeat of this episode,” he said. One reason other investment banks may not need an individual rescue from the Fed is that they already have received more than $30 billion in emergency loans under a separate program the Fed instituted on the same day it arranged the Bear Stearns buyout.
The Fed threw open its emergency lending window to 20 international brokers that buy and sell bonds from the Fed. Previously, only banks had access to the Fed’s discount window.
Now that Wall Street firms have access to Fed funds, Mr. Bernanke said the central bank should have regulatory powers to oversee their risky lending activities. He said the central bank already has sent examiners to work alongside SEC oversight staff at each of the firms.
The loans the investment firms received carry the same terms as those the Fed provides to banks, Mr. Bernanke said. The Fed requires banks to present collateral that is discounted in value, and it retains the right to exchange collateral that “goes bad” due to defaults. The loans Bear Stearns provided as collateral are current and “investment grade,” he added.
“To my knowledge, we’ve never lost a penny in those operations over the years.”
Mr. Bernanke said the Fed’s extensive market interventions since December, injecting an estimated $400 billion into floundering credit markets, have succeeded in bringing some calm to the markets and offsetting what otherwise would have been steep increases in mortgage rates even for borrowers with the best credit.
