Bernanke: Economy on verge of recovery, worst of crisis is over

— -- Federal Reserve Chairman Ben Bernanke on Friday gave his most upbeat economic outlook yet, saying the recession seems to be ending and a recovery should begin shortly.

"After contracting sharply over the past year, economic activity appears to be leveling out, both in the United States and abroad, and the prospects for a return to growth in the near-term appear good," Bernanke said at the Fed's annual conference in Jackson Hole, Wyoming.

Most economists expect the recession to end in the third quarter, with many saying it's already over. Many, however, expect unemployment — now at 9.4%— to peak above 10% early next year.

His assessment was even more emphatic than the Fed's policy statement last week, which simply said "economic activity is leveling out" — meaning the economy has stopped shrinking.

Bernanke also appeared to provide a slightly more positive prognosis for the pace of the recovery, saying it's "likely to be relatively slow at first, with unemployment declining only gradually from high levels." In previous public statements the Fed chairman generally indicated the recovery likely would be slow and gradual.

Some economists, however, have positively revised their outlooks recently. Factory output and new orders grew last month at the fastest pace in two years. Housing starts in June rose to the highest level since last fall. And both stock and corporate bond markets have climbed sharply.

Yet in light of the improvement, the Fed said last week it will conclude its purchases of $300 billion in Treasury securities by the end of October. That's a sign the central bank believes the economy is healthy enough to wind down an extraordinary initiative to pump cash into frozen credit markets to lower interest rates on loans for consumers and businesses.

Still, with credit markets still tight and many banks teetering, Bernanke cautioned that "critical challenges remain."

"Strains persist in many financial markets across the globe, financial institutions face significant additional losses, and many businesses and households continue to experience considerable difficulty gaining access to credit," Bernanke told leaders of central banks from around the world and economists.

Bernanke, whose term expires in January and is widely believed to be seeking reappointment by President Obama, also used the speech, titled "Reflections on a Year of Crisis," to tout the Fed's wide-ranging response to the economic crisis last fall. The response of both the Fed and Treasury Department included multi-billion dollar bailouts of AIG, Bear Sterns, Citigroup and the new Bank of America-Merrill Lynch combination, as well as the takeover of Fannie Mae and Freddie Mac. The Fed also provided massive funds to banks to lend to each other as financial panic spread worldwide.

"Policymakers in the United States and around the globe responded with speed and force to arrest a rapidly deteriorating and dangerous situation," Bernanke said at the gathering, sponsored by the Federal Reserve Bank of Kansas City.

"Without these speedy and forceful actions, last October's panic would likely have continued to intensify, more major financial firms would have failed, and the entire global financial system would have been at serious risk."

Bernanke defended the government's decision not to bail out Lehman Bros. — a move that economists say exacerbated the crisis. Bernanke said the government could not lend money to Lehman because the investment bank did not have sufficient capital to serve as collateral and no buyer for the company emerged.

"The firm's failure was, unfortunately, unavoidable," he said.

Bernanke endorsed President Obama's proposed reform of the financial system, which has lost momentum as some members of Congress have criticized a plan to give the Fed more power to prevent a broad collapse of the system.

"Looking forward, we must urgently address structural weaknesses in the financial system, in particular the regulatory framework, to ensure that the enormous costs of the past two years will not be borne again."