Bernanke pledges 'adequate insurance against downside risks'

Bloomberg

The Fed ``will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks,'' Bernanke said in the text of prepared remarks to a Senate Banking Committee hearing today.

Bernanke and his colleagues are trying to steer the economy through a credit crunch that began with rising delinquencies on subprime mortgages and is now in its seventh month. The Fed chief acknowledged a widening impact on households and consumers from financial volatility, in remarks that may reinforce investors' anticipation for further interest-rate cuts.

``More-expensive and less-available credit seems likely to continue to be a source of restraint on economic growth,'' Bernanke said. ``The outlook for the economy has worsened in recent months, and the downside risks to growth have increased.''

Fed officials lowered rates at the fastest pace in two decades last month after investors retreated from risk, the unemployment rose and consumer spending slowed. Futures markets show traders expect another half-point reduction, to 2.5 percent, by the end of the next Federal Open Market Committee meeting on March 18.

Bernanke said his own forecast calls for the economy to avoid a recession this year.

BERNANKE'S 'BASELINE'

``My baseline outlook involves a period of sluggish growth, followed by a somewhat stronger pace of growth starting later this year as the effects of monetary and fiscal stimulus begin to be felt,'' the 54-year-old Fed chairman said. ``Although the baseline outlook envisions an improving picture, it is important to recognize that downside risks to growth remain.''

The worst housing slump in a quarter century has combined with lower stock prices and elevated inflation to sap household wealth.

The economy lost 17,000 jobs in January, the first drop in more than four years. The Standard & Poor's 500 Index has fallen three consecutive months, and is down 7.3 percent so far this year. Residential investment subtracted 1.2 percentage point from growth last quarter, the eighth straight decline, according to government statistics.

``The softer labor market, together with factors including higher energy prices, lower equity prices, and declining home values, seem likely to weigh on consumer spending in the near term,'' Bernanke said.

STIMULUS PACKAGE

President George W. Bush yesterday signed a $168 billion stimulus package designed to buttress spending. Rebate checks will be sent to more than 130 million Americans beginning in May. The measure also includes investment incentives for businesses.

Still, economists such as Harvard University's Martin Feldstein said the plan may not keep the U.S. out of a recession.

``Even if it isn't avoided, will it be enough to cause this to be a modest downturn?'' Feldstein, president of the National Bureau of Economic Research, said in a Bloomberg Television interview on Feb. 12. ``We can't be sure because of the problems in the credit markets,'' he said, estimating the chance of a recession at ``close to 50-50.''

The Federal Open Market Committee cut the benchmark lending rate a half-point to 3 percent last month, after an emergency 75 basis point reduction in the federal funds rate Jan. 22.

BOND PREMIUMS

Still, credit markets remain under stress. The extra yield investors demand to buy investment grade U.S. corporate bonds rose to 2.37 percentage points Feb. 12 from 2.24 percentage points on Jan. 21, according to Merrill Lynch & Co. data.

Fed rate cuts are ``coming when banks already have a significant number of impairments and are trying to protect their own balance sheets,'' said Joshua Rosner, managing director at the New York research firm Graham Fisher & Co. ``They aren't interested in passing on that cut to most borrowers.''

Writedowns and credit losses at the world's largest banks and securities firms have exceeded $146 billion since the beginning of 2007.

Bernanke said ``in the months ahead'' Fed officials will be monitoring inflation closely.

``To date, inflation expectations appear to have remained reasonably well anchored,'' he said. ``Our policy stance must be determined in light of the medium-term forecast for real activity and inflation, as well as the risks to that forecast.''