Grand Theft Economics

Bernanke Sees 2010 Recovery ‘Only If’ Banks Stabilize

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Federal Reserve Chairman Ben S. Bernanke said the U.S. economy is in a “severe” contraction, and warned the recession may last into 2010 unless policy makers can stabilize the financial system.

“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,” Bernanke said in remarks to the Senate Banking Committee in Washington.

Bernanke’s call for “strong” action by policy makers comes as the Obama administration works on fleshing out the details of its bank-rescue plan. Financial stocks have slumped further since Treasury Secretary Timothy Geithner unveiled his outline Feb. 10, with officials opening talks with Citigroup Inc. about providing further help to the lender.

“Downside risks probably outweigh those on the upside,” Bernanke said today in his semiannual testimony on the economy, adding that the Fed’s own forecast was clouded by “considerable uncertainty.”

The 55-year-old chairman faces what former Fed chief Paul Volcker called last week a “massive economic crisis,” with rising unemployment, an accelerating decline in output and more than $700 billion in losses and writedowns at financial firms. Bernanke’s outlook was the most negative of any of the semiannual testimonies he has provided to Congress in his three years at the central bank’s helm.

Consumer Confidence

A private survey today showed that confidence among U.S. consumers sank to a record low in February. The Conference Board’s index declined more than forecast to 25 this month, the lowest level since data began in 1967, the New York-based research group said today. Stocks still snapped a six-day decline, with the Standard & Poor’s 500 Index up 1.6 percent at 755.10 at 11:04 a.m. in New York.

“Bernanke’s message is that all available tools are going to be used to break this adverse feedback loop” of mutually reinforcing weakness in the economy and credit, said John Ryding, chief economist at RDQ Economics LLC, in New York.

The Fed has tried to alleviate the slump by providing $1.9 trillion in credit and cutting the benchmark interest rate to as low as zero percent. Officials see the rate remaining “exceptionally low” for some time, Bernanke said.

Global Impact

Bernanke said the “global nature of the slowdown” added to risks that U.S. exports and financial conditions could worsen. “Another risk derives from the destructive power of the so- called adverse feedback loop, in which weakening economic and financial conditions become mutually reinforcing,” he told lawmakers.

“Strong government action” is critical to stabilize markets and financial firms, the central bank chief said.

The Fed, Treasury and other financial regulators pledged yesterday to inject additional funds into the nation’s major banks to keep them afloat and will this week begin examinations to determine whether they have enough capital.

Financial stocks have tumbled, with the Standard & Poor’s Financials Index falling 43 percent so far this year. Shareholders have fled the common stock of many banks, fearing the government could make dilutive capital injections or nationalize them. Citigroup Inc. has plunged 68 percent this year, while Bank of America Corp. is down 72 percent.

Loan Program

The Fed may step up efforts to stem the worst credit crisis in seven decades by expanding a program aimed at supporting consumer loans and small business loans to $1 trillion from $200 billion and adding commercial real estate. It is also buying $600 billion of debt sold by government-backed housing finance companies and mortgage-backed securities they guarantee.

While the Fed said Feb. 6 that it would announce this month a start date for the Term Asset-Backed Securities Loan Facility, Bernanke stopped short of giving a date, saying today that it’s “expected to begin extending loans soon.”

“We believe that these actions, combined with the broad range of other fiscal and financial measures being put in place, will contribute to a gradual resumption of economic growth and improvement in labor-market conditions in a context of low inflation,” Bernanke said.

Treasuries Purchases

A minority of officials including Richmond Fed President Jeffrey Lacker advocate purchasing long-term Treasuries over targeted credit programs to bring down borrowing costs. Bernanke omitted mention of the purchases from his remarks for the third straight time this month. The previous omissions indicated to some investors that the Fed was backing away from a proposal he floated in December.

The FOMC’s statement last month said the Fed was “prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets.”

January forecasts by Fed officials suggest that “a full recovery of the economy from the current recession is likely to take more than two or three years,” Bernanke told lawmakers.

The U.S. unemployment rate rose to 7.6 percent last month, the highest level since 1992. Losses spanned almost all industries from trucking and construction to retailing and finance.

Fed officials expect unemployment in the fourth quarter to average 8.5 percent to 8.8 percent, which would be the highest since 1983, according to their January forecasts. Gross domestic product will contract 1.3 to 0.5 percent, and inflation will run at just 0.3 percent to 1 percent this year, the projections indicate.

Jobs Forecast

Fed officials don’t see labor markets improving until 2011, when growth forecast at 3.8 percent to 5 percent reduces the unemployment rate to a range of 6.7 percent to 7.5 percent.

President Barack Obama is trying to make up for the loss in U.S. output with $787 billion in federal spending and tax cuts. Economic models used by Macroeconomic Advisers LLC indicate the stimulus package could keep the jobless rate at about 8.8 percent instead of the 9.5 percent rate that would result without the package.

Consumer spending, which accounts for more than two-thirds of the U.S. economy, dropped at a 3.5 percent annual rate last quarter following a 3.8 percent drop the previous three months. It was the first time purchases declined by more than 3 percent in consecutive quarters since records began in 1947.

The crisis has now spread to retailers, such as Circuit City Stores Inc., which filed for bankruptcy last year, and automakers such as General Motors Corp., which is seeking as much as $16.6 billion in federal loans in addition to the $13.4 billion it has already received.

by Craig Torres and Scott Lanman
Bloomberg

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