WASHINGTON (Reuters) - Federal Reserve Chairman Ben Bernanke on Wednesday conceded for the first time the U.S. economy may slip into recession, but said growth should pick up later this year as the impact of interest rate cuts and other emergency steps take root.
Bernanke told a congressional panel that the economy appeared to be growing, but warned it could shrink in the first half of 2008. It was Bernanke’s first testimony on Capitol Hill since the U.S. central bank helped rescue investment bank Bear Stearns in mid-March, an action he defended as averting a collapse that would have been calamitous.
“Recession is possible,” Bernanke told the Joint Economic Committee. “Our estimates are that we are slightly growing at the moment, but we think that there’s a chance that for the first half as a whole, there might be a slight contraction.”
The Fed has lowered benchmark interest rates by three percentage points to 2.25 percent since mid-September to help put a floor under an economy hit hard by a housing slump and credit market turmoil.
Bernanke said those rate cuts and other emergency measures to thaw frozen credit markets should promote growth over time — remarks traders in financial markets saw as a signal that the Fed’s sharp rate-cutting action may be drawing to an end.
Some analysts said the absence of a specific pledge by Bernanke to act as needed to help the economy, a standard feature of recent Fed statements, buttressed that view. “There is a conspicuous absence of policy commitment in this statement,” said Jan Hatzius, chief economist at Goldman Sachs.
U.S. stock prices slipped, with the blue chip Dow Jones industrial average .DJI closing down 48.53 points at 12,605.83. Prices for U.S. government bonds also fell, as did the value of the dollar.
Bernanke defended the Fed’s role in providing emergency funding to prevent an abrupt bankruptcy at Bear Stearns, which had been the fifth largest U.S. investment bank, which he said could have caused a “chaotic” market reaction.
The Fed, informed on March 13 that Bear Stearns was on the verge of collapse, decided to provide a $30 billion credit line backed by the firm’s shaky assets to facilitate its purchase by JPMorgan Chase. The action raised questions about the central bank’s willingness to shield investors from risks.
“Our financial system is extremely complex and interconnected, and Bear Stearns participated extensively in a range of critical markets,” Bernanke said.
“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,” he said.
If financial markets had been in more solid condition, policy-makers may have held back, but decided under current conditions that it was too risky to allow the firm to fail unexpectedly, Bernanke said.
“That was an extraordinary thing to do,” he said. “I thought about it long and hard. I would hope not to ever do it again.”
Bernanke said financial markets remain under considerable strain but that emergency measures to provide liquid funds have been helpful in alleviating some of the stresses. Funding pressures on large financial institutions seem to have eased somewhat, and some markets, including the market for mortgage-backed securities, appear to be more liquid, 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,” Bernanke said. “I remain confident in our economy’s long-term prospects.”
He said the Fed expects the economy to strengthen in the second half of the year, and for growth to proceed at or a little above its sustainable pace in 2009.
Bernanke, however, said uncertainty surrounding the outlook was “quite high” and that there was a risk the Fed’s forecast would prove too optimistic. He also said inflation was a concern, although price gains should moderate.
Bernanke said a Treasury Department proposal to overhaul financial regulation, which would give the Fed responsibility for overall financial market stability but remove it from front-line bank examination duties, could hurt the Fed’s ability to keep tabs on the health of the financial system.
“We could not successfully carry out this mission if we had to rely entirely on second hand reports from primary supervisors of these individual institutions,” he said.