Bernanke: Economy Suffering 'Severe Contraction'
In testimony prepared for the Senate Banking Committee, Bernanke said the economy is likely to keep shrinking in the first six months of this year. Housing, credit and financial crises -- the worst since the 1930s -- plunged the economy into its worst downhill slide in a quarter-century at the end of last year.
Bernanke hoped that the current recession, now in its second year, will end this year.
But he said there were significant risks to that forecast and any economic turnaround would hinge on the success of the Fed and the Obama administration in getting credit and financial markets to operate more normally again.
"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.
Among the risks to any recovery are if economic and financial troubles in other countries turn out to be worse than anticipated, which would hurt U.S. exports and further aggravate already shaky financial conditions in the United States.
Another concern is that the Fed and other Washington policymakers won't be able to break a vicious cycle where disappearing jobs, tanking home values and shrinking nest eggs are forcing consumers to cut back sharply, worsening the economy's tailspin. In turn, battered companies lay off more people and cut back in other ways.
"To break that adverse feedback loop, it is essential that we continue to complement fiscal stimulus with strong government action to stabilize financial institutions and financial markets," Bernanke said.
In an effort to revive the economy, the Fed has slashed a key interest rate to an all-time low and Obama recently signed a $787 billion stimulus package of increased government spending and tax cuts.
In addition, Treasury Secretary Timothy Geithner has revamped a controversial $700 billion bank bailout program to include steps to partner with the private sector to buy rotten assets held by banks as well as expand government ownership stakes in them -- all with the hopes of freeing up lending. The Obama administration also will spend $75 billion to stem home foreclosures.
Those and other bold steps -- including a soon-to-be-operational Fed program to boost the availability of consumer loans -- for autos, education, credit cards and other things -- should over time provide relief and promote an economic recovery, Bernanke said.
Radical actions taken by the government since last fall when the financial crisis intensified have relieved some credit and financial strains, Bernanke said.
"Nevertheless, despite these favorable developments significant stresses persist in many markets," he said. "Notably most securitization markets remain shut ... and some financial institutions remain under pressure."
Although Bernanke didn't mention any such financial institutions by name, Citigroup Inc. -- the industry's troubled titan -- is apparently in line for additional government help.
Critics worry the Fed's actions have the potential to put ever-more taxpayers' dollars at risk and encourage "moral hazard," where companies feel more comfortable making high-stakes gambles because the government will rescue them.
All the negative forces have battered consumers and businesses.
"The economy is undergoing a severe contraction," Bernanke said.
The nation's unemployment rate is now at 7.6 percent, the highest in more than 16 years. And it will climb higher -- even in the best-case scenario that an economic recovery happens next year.
The Fed expects the jobless rate to rise to close to 9 percent this year, and probably remain above normal levels of around 5 percent into 2011.
The recession, which started in December 2007, already has killed a net total of 3.6 million jobs.
To brace the economy, many analysts predict the Fed will leave its key rate at record lows through the rest of this year. The Fed has said repeatedly that it will explore expanding existing programs to provide loans or buy debt, or come up with new tools to fight the crises.
The Fed is "committed to using all available tools to stimulate economic activity and to improve financial market functioning," Bernanke told lawmakers Tuesday.