Bernanke Warns Economy Worsening

(AP) — Federal Reserve Chairman Ben Bernanke told Congress Thursday the economy is deteriorating and signaled a readiness to keep on lowering a key interest rate to shore things up.

Bernanke also told the Senate Banking Committee that the one-two punch of housing and credit crises has greatly strained the economy. And he forecast sluggish growth in the near term. Bernanke also noted that hiring has slowed and that people are likely to tighten their belts further because of high energy prices and plummeting home values.

“The outlook for the economy has worsened in recent months, and the downside risks to growth have increased,” Bernanke said. “To date, the largest economic effects of the financial turmoil appear to have been on the housing market, which, as you know, has deteriorated significantly over the past two years or so.”

Bernanke also told senators that the “virtual shutdown” of the market for subprime mortgages given to people with blemished credit histories or low incomes – and a reluctance by skittish lenders to make “jumbo” home loans exceeding $417,000 – have aggravated problems in the housing market.

Unsold homes have piled up and foreclosures have climbed to record highs.

“Further cuts in homebuilding and in related activities are likely,” Bernanke cautioned.

Given all the dangers facing the economy, he said, the Fed “will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks.” Bernanke indicated that additional rate cuts were likely. Still, he voiced hope that economic growth will improve later this year.

Bernanke’s Hill appearance with Treasury Secretary Henry Paulson and Christopher Cox, chairman of the Security and Exchange Commission, came amid escalating worry that the economy may be drifting into recession. The troubles in the housing and credit markets alone threaten to push the economy into its first recession since 2001 – if it hasn’t fallen into one already.

Bernanke and Paulson don’t believe the country will fall into a recession. Their forecasts still call for growth, albeit slow growth, they said. However, the pair did say Thursday that the administration and the Fed are expected to downgrade their economic forecasts for this year.

“It would be less, but I do believe we’ll keep growing,” Paulson said. Bernanke said a new Fed forecast due next week will “show lower projections of growth ….growth looks to be weak, but still positive.”

On Wall Street, Bernanke’s bearish assessment pulled stocks lower. The Dow Jones industrials were down more than 100 points in afternoon trading.

The Federal Reserve, which started lowering a key interest rate in September, has recently turned much more aggressive. Over the span of just eight days in January, it slashed rates by 1.25 percentage points – the biggest one-month rate reduction in a quarter-century. Economists and Wall Street investors believe the Fed will cut rates even more at its next meeting in March and probably again in April.

“Our economy is clearly in trouble,” said the committee’s chairman, Sen. Christopher Dodd, D-Conn. Restoring investor and consumer confidence, he said, is critical “if we are going to get back on our feet again.”

Bernanke said his forecast is for the economy to continue to endure a “period of sluggish growth.” That would be “followed by a somewhat stronger pace of growth starting later this year” as the effects of the Fed’s rate cuts and a newly enacted stimulus package begin to be felt. The $168 billion package, which includes rebates for people and tax breaks for businesses, was speedily passed by Congress last week and signed into law on Wednesday by President Bush.

Sen. Richard Shelby, R-Ala., was skeptical, saying he thought the energizing impact of rebates would be “negligible” and likened the action to “pouring a glass of water into the ocean.”

Even though Bernanke’s forecast envisions an improving economic picture later this year, the Fed chief said it was nonetheless “important to recognize that downside risks to growth remain, including the possibilities that the housing market or the labor market may deteriorate to an extent beyond that currently anticipated” or that credit will become even harder to secure.

That’s why, for now, Bernanke indicated the Fed is still inclined to lower interest rates.

Yet, that could change, depending on how the economy and inflation unfold.

“A critical task for the Federal Reserve over the course of this year will be to assess whether the stance of monetary policy is properly calibrated to foster our mandated objectives” of promoting healthy employment and economic growth while keeping inflation under control.

Sen. Robert Menendez, D-N.J., criticized policymakers for what he believed was a too slow response to the housing crisis. “We count on those at the top … to sound an alarm,” during a crisis, he said. Instead, “what we got was a snooze button … we’ve been behind the curve.”

Noting spreading credit problems, Sen. Charles Schumer, D-N.Y., asked whether policymakers underestimated the severity of the situation.

Replied Paulson: “It’s one thing to identify a problem. It’s another thing to know exactly what to do about it.”

Lax credit standards during the days of the housing boom provided the spark that led to the current economic woes, Paulson said. “We had a dry forest out there,” the secretary said.

Meanwhile, Paulson said the administration’s efforts to help people at risk of losing their homes is paying off.

Paulson said that in the final three months of last year, more than 470,000 homeowners got help from companies servicing their mortgages and almost 30 percent of those received a loan modification. He insisted the administration was working hard to help, and called the problems facing some struggling homeowners “heartrending.”

In terms of clues for an economic turnaround, Bernanke said the Fed would need to see signs of stabilization in the housing and labor markets and improvements in credit markets. For now, he said, the Fed doesn’t expect a “rip roaring” jobs market. Employers in January cut jobs for the first time in more than four years.