Updated from 12:27 p.m. EDT
Chairman Ben Bernanke on Wednesday acknowledged the possibility of recession, as lawmakers grilled him on the government's bailout of
( BSC) and the merits of federal aid for struggling homeowners.
In his latest economic forecast, Bernanke predicted that real GDP "will not grow much, if at all, over the first half of 2008 and could even contract slightly." He later crossed a rhetorical line for government officials by acknowledging that "recession is possible" for the economy this year in response to a question. A recession is widely defined as two straight quarters of contraction in GDP growth.
Bernanke appeared to be backing off his previous expectation of "moderate growth" expressed in the Fed's
Bernanke did reiterate that the Fed expects the economy to strengthen in the second half of the year, due to low interest rates combined with the legislated tax rebates that consumers will receive later this year. He also forecasted economic growth in 2009, but he qualified the central bank's outlook by noting that "risks remain to the downside," due to persistent turmoil in financial markets and heightened uncertainty about the future.
"Although our recent actions appear to have helped stabilize the situation somewhat, financial markets remain under considerable stress," said Bernanke, in his prepared remarks to the Joint Economic Committee in Congress. "Pressures in short-term bank funding markets, which had abated somewhat beginning late last year, have increased once again. Many lenders have been reluctant to provide credit to counterparties, especially leveraged investors, and have increased the amount of collateral they require to back short-term security financing agreements.
"To meet those demands, investors have reduced their leverage and liquidated holdings of securities, putting further downward pressure on security prices," Bernanke added.
Bear Stearns notified the Fed on March 13 that its liquidity position was eroding and the investment bank was on the verge of bankruptcy. In response, the Fed backstopped nearly $30 billion of Bear's riskiest mortgage-related securities to orchestrate a swift acquisition of the bank by
( LEH) for a stunning $2 a share. JPMorgan later renegotiated the price up to $10 a share.
"Normally, the market sorts out which companies survive and which fail, and that is as it should be," said Bernanke. "However, the issues raised here extended well beyond the fate of one company."
He noted that Bear Stearns participates extensively in critical financial markets and the fallout from its bankruptcy could have been difficult to contain.
"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," said Bernanke. "The company's failure could also have cast doubt on the financial positions of some of Bear Stearns' thousands of counterparties and perhaps of companies with similar businesses."
Based on Bernanke's willingness to extend government aid to Bear Stearns to prevent further catastrophe, the Democratic-controlled Congress pressed the Fed chairman on whether a fiscal bailout for homeowners facing foreclosure is appropriate, given the damage that falling home prices are inflicting on the broader economy.
Sen. Edward Kennedy (D.,Mass.) noted that U.S. consumers are facing a cash crunch as the value of their money has declined along with the value of their homes, while borrowing and energy costs have spiked.
"What is your policy recommendation for us to remedy this?" asked Kennedy. "What should we do?"
Bernanke declined to make a policy recommendation, saying that those decisions should be made by the Congress.
Stocks were recently moving modestly higher during Bernanke's testimony, with the
Dow Jones Industrial Average
up 0.2%, the
gaining 0.4% and the
was adding 0.6%.
Financial stocks, which are under close scrutiny after the Bear Stearns debacle, were adding to the market's strength. Shares of
( LEH) were recently up 1%, while shares of
( MER) were up 3.4% and shares of
( MER) were up 0.6%.
Bernanke will appear before Congress again Thursday, testifying to the Senate's Committee on Banking, Housing and Urban Affairs.
The Fed's actions surrounding Bear Stearns have raised the specter of a
on Wall Street to prevent future market breakdowns and government bailouts. In addition to the funds provided to the Bear, Bernanke noted that the Fed has recently established three new lending facilities in additional to its traditional discount window for providing funding to traditional banks and investment banks -- the first time the central bank has taken such a step since the Great Depression.
Also, the Fed has set up additional currency swap lines with the European Central Bank and the Swiss National Bank.
"Using these swap lines, the participating central banks are providing dollar liquidity to financial institutions in their jurisdictions, which should improve the functioning of the global market for dollar funding," said Bernanke. "These facilities and programs will be kept in place as long as conditions warrant their ongoing use."
All these actions have come in the midst of aggressive open market operations by the Fed to lower short-term interest rates and restore confidence to the nation's shell-shocked credit markets.
The Fed reduced its target for the federal funds rate by a total of 125 basis points in January and by an additional 75 basis points at its March meeting. That leaves the current target at 2.25% -- a full three percentage points below its level last summer.
Despite these actions, credit markets remain in a logjam. Stocks plunged in the first quarter in anticipation of a consumer spending slowdown. The U.S. job market has suffered two successive months of contraction. Housing prices are posting their largest declines since the Great Depression. The value of the U.S. dollar has tanked, while futures price for commodities like gold and crude oil have soared -- even while factoring in the latest selloffs in those markets.
Moreover, inflation has picked up over the last year, Bernanke noted, but he said core inflation -- excluding volatile food and energy prices -- has recently edged lower.
"We expect inflation to moderate in coming quarters," said Bernanke. "That expectation is based, in part, on futures markets' indications of a leveling out of prices for oil and other commodities, and it is consistent with our projection that global growth -- and thus the demand for commodities -- will slow somewhat during this period."
In the face of the myriad of fiscal and economic challenges for the U.S., Bernanke sounded a note of confidence in the long-term health of the largest economy in the world.
"Clearly, the U.S. economy is going through a very difficult period, but among the great strengths of our economy is its ability to adapt and to respond to diverse challenges," 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. I remain confident in our economy's long-term prospects."
Know What You Own
: BSC operates in the financial services industry, and some of the other stocks in its field include
Bank of America
( LEH). These stocks were recently trading at ($24.66, +3.44%), ($180.44, +2.02%), ($49.97, +2.29%), ($46.55, +1.15%) and ($45.35, +2.28%) respectively. For more on the value of knowing what you own, visit TheStreet.com's