Bernanke Says U.S. Economy May Slip Into a Recession

Federal Reserve Chairman Ben S. Bernanke acknowledged for the first time that a U.S. recession is possible because homebuilding, employment and consumer spending will deteriorate.

It now appears likely that real gross domestic product will not grow much, if at all, over the first half of 2008 and could even contract slightly, Bernanke told Congress's Joint Economic Committee today. He also said the Fed's emergency loan to Bear Stearns Cos. followed a March 13 warning by the firm that it would have to file for bankruptcy the next day.

Bernanke, making his first extensive public comments since the Fed's decisions two weeks ago to back the takeover of Bear Stearns and lower interest rates by 0.75 percentage point, is trying to fend off criticism of the deal while struggling to prevent a deeper economic slump. He said he thought long and hard about the decision, and doesn't anticipate the need for a similar rescue of another company.

While the Fed expects the economy to return to its long- term growth pace in 2009, in light of the recent turbulence in financial markets, the uncertainty attending this forecast is quite high and the risks remain to the downside, he said.

Treasury notes and stocks were little changed after Bernanke's remarks. The benchmark 10-year note yielded 3.59 percent at 12:26 p.m. in New York.

Bleaker Outlook

This is a much more pessimistic assessment of the economy than what the Fed had three months ago or six months ago, said John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina, who previously worked as a senior economist in Congress. Certainly, the Fed and the capital markets have been surprised the economy has slowed so quickly.

The Fed, in an emergency decision on Sunday, March 16, voted to authorize a loan against $29 billion of Bear Stearns assets, including mortgage-backed securities, so JPMorgan Chase & Co. would buy the company.

Bernanke, questioned by lawmakers about putting taxpayer money at risk, expressed confidence the Fed won't lose money on the Bear Stearns deal. The Fed last week said JPMorgan will shoulder the first $1 billion of any losses.

I feel reasonably confident that we'll be able to recover all the principal and indeed some interest, and there is some chance of even upside beyond that, Bernanke said.

Bear Collateral

The Fed chief also said the central bank's investment adviser, BlackRock Inc., has gone through those assets, and they are confident, or at least reasonably confident, that we will be able to recover the full amount if we dispose of these assets on a measured basis, rather than to sell them all at once.

The central bank also expanded its powers last month by opening up lending directly to Wall Street investment banks. In addition, the Fed cut the interest rate on loans to banks, and now securities firms, by a quarter point.

Two days later, the Federal Open Market Committee cut the main lending rate to 2.25 percent and said the outlook for economic activity has weakened further. Officials also showed renewed concern about inflation, making a smaller reduction than traders anticipated. Two policy makers dissented in favor of less aggressive action.

The Fed agreed to the emergency Bear Stearns loan to prevent a disorderly failure of the company and the unpredictable but likely severe consequences of such a failure for market functioning and the broader economy, Bernanke said.

Senate Probes

The Senate's banking and finance committees have started separate inquiries into the transaction, raising questions about the role of the regulators in facilitating it.

With financial conditions fragile, the sudden failure of Bear Stearns likely would have led to a chaotic unwinding of positions and could have severely shaken confidence, the Fed chief said.

Bernanke said that the U.S. economy is going through a very difficult period.

The U.S. economy grew at an annual pace of 0.6 percent from October to December. Growth probably slowed to a 0.2 percent annual rate in the first quarter, according to the median estimate of analysts surveyed by Bloomberg News.

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. Policy makers expect that the rate cuts and financial-market actions this year will help to promote growth over time and to mitigate the risks to economic activity.

Fed Statement

He didn't repeat the expectation of moderate growth from the FOMC's March 18 statement.

Traders expect the Fed to lower the overnight interbank lending rate by a quarter-point at the next FOMC meeting April 29-30, based on futures prices.

Separately today, the International Monetary Fund cut its forecast for global growth this year and said there's a 25 percent chance of a world recession, citing the worst financial crisis in the U.S. since the Great Depression. Also, orders to U.S. factories fell more than forecast in February, a Commerce Department report showed.

Treasury Secretary Henry Paulson told Bloomberg Television in an interview from Beijing that the IMF numbers appear overblown to me. He indicated a willingness to consider congressional plans to stem foreclosures by expanding government guarantees for mortgages.

Inflation `Concern'

Bernanke said that inflation has also been a source of concern, with higher commodity prices and the weaker dollar. At the same time, he said the Fed expects inflation to moderate in coming quarters, echoing the FOMC statement. A leveling out of commodity prices and slower global growth will help, Bernanke said.

The Fed's preferred inflation gauge, which excludes food and energy costs, has increased at least 2 percent from the year earlier, the upper end of officials' long-term projections, for five straight months through February. Bernanke said the rate has edged down recently.

Senator Charles Schumer, the New York Democrat who chairs the House-Senate panel, said today that the Fed's actions on Bear Stearns provided some much-needed breathing room to the financial markets.

But there are many legitimate, looming, and unanswered questions about what happened both before and after the Bear Stearns action, Schumer said.