Fed Chairman Says Recession Will Extend Through the Year

By CATHERINE RAMPELL and JACK HEALY
Published: February 24, 2009

The Federal Reserve chairman, Ben S. Bernanke, offered a sober assessment of the national economy and the prospects of recovery to Congress on Tuesday, as reports of plunging housing prices and consumer confidence reinforced the grim outlook.

Mr. Bernanke told the Senate banking committee that the Federal Reserve was doing everything it could to unlock credit markets and encourage lending and borrowing. Still, a full recovery is potentially at least a year away, he said, and that is if all goes according to plan.

“If actions taken by the administration, the Congress and the Federal Reserve are successful in restoring some measure of financial stability — and only if that is the case, in my view — there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery,” Mr. Bernanke said.

Though he lingered over the seriousness of the financial crisis enveloping the country, the Fed chairman buoyed investors by stating his resistance to any nationalization of the big banks. The prospect of the government taking up to a 40 percent stake in Citigroup in return for more assistance has pushed the idea to the fore.

“We don’t need majority ownership to work with the banks,” he said, arguing that federal agencies have enough supervisory power to nurse banks back to full health. Taking over banks more formally would needlessly “destroy the franchise value” of the institutions, he said.

As required, Mr. Bernanke addressed the Fed’s dual mandate of stable prices and maximum employment in the first installment of his twice-annual report to each house of Congress. The former part of the Fed’s mission has largely been met, with prices more or less where they were a year ago, and inflation expected to glide under 1 percent this year.

But the job market continues to deteriorate. The unemployment rate, which rose to 7.6 percent in January, will probably reach 8.5 to 8.8 percent by the end of the year, according to Mr. Bernanke’s report to Congress. The gross domestic product, which fell at an annual rate of 3.8 percent in the last quarter of 2008, will contract 0.5 to 1.25 percent this year.

Two barometers of the economy, the housing market and consumer attitudes, turned in dismal readings the morning the chairman appeared on Capitol Hill.

Home prices in the United States fell at the fastest pace on record in December, according to the Standard & Poor’s Case-Shiller home price index. The value of single-family homes in 20 major metropolitan areas was 18.5 percent lower in December than a year earlier.

According to a report by the private Conference Board, consumers described their current situation and their expected situation in six months in harsh terms. The group’s index of consumer confidence dropped to a new low of 25 in February, from 37.4 a month earlier. That was the lowest since it began tracking consumer sentiment in 1967.

Mr. Bernanke acknowledged there was a risk that the economy would become even worse than the Fed is currently forecasting.

The global nature of the economic slowdown, as well as a “so-called adverse feedback loop” — the idea that economic and financial conditions become mutually reinforcing — threaten to delay recovery, he said.

He urged support for the significant — and sometimes unpopular — fiscal and monetary interventions being made by the government.

Some senators, like Evan Bayh, a Democrat from Indiana, questioned whether it was fair or even wise for the government to continue bailing out financial institutions and homeowners who had behaved irresponsibly.

In response, Mr. Bernanke compared the government’s situation to one in which a neighbor smoked in bed and accidentally caught his house on fire. You could punish the neighbor for his irresponsibility by not calling the fire department, Mr. Bernanke said. But by the time the neighbor learned his lesson, the entire neighborhood would have burned down.

He said policy makers should look at their task as two-pronged. The first goal is to prevent the economy from worsening in the near term. The second is to devise substantial, longer-term reforms of the financial regulatory system, to prevent future irresponsibility.

Mr. Bernanke repeatedly advocated revamping federal oversight of financial institutions, which are now supervised by a patchwork of federal agencies that monitor different functions and, he said, never get a full picture of a company’s overall financial health.

The Fed, he suggested, should look at the smaller companies underneath the umbrella of a bank holding company so that the various risks a financial institution takes do not “get out of the line of vision of regulators.”

In a joint program with other federal regulatory agencies, the Fed announced Monday that the nation’s 20 biggest banks would have to undergo a “stress test” to determine their viability. The test will be used to measure whether banks have enough capital to survive a worsening downturn.

To Mr. Bernanke’s first goal of shoring up the economy, the Fed has taken extraordinary steps in recent months to increase the flow of credit to businesses and households.

When it comes to setting interest rates, it has nearly exhausted its options. In December the Federal Open Market Committee lowered its key interest rate to virtually zero, to encourage lending.

The Fed has also been buying mortgage-backed securities that have been guaranteed by the federal government.

It has expanded its lending operations to banks. In one new program, it aims to finance consumer loans, recently announcing it would expand that effort in both size and scope. Through a commercial paper program, it is providing businesses with loans in exchange for short-term i.o.u.’s.

Mr. Bernanke said these actions had contributed to improvements in short-term financing markets and the commercial paper market, as well as to declines in rates for conforming mortgages — loans that meet Fannie Mae and Freddie Mac guidelines — and the benchmark rate, known as Libor, on which borrowing costs for consumers and businesses are often based.

Catherine Rampell reported from Washington and Jack Healy from New York.

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