Bernanke urges bold action on economy

WASHINGTON -- Federal Reserve Chairman Ben Bernanke told Congress Tuesday that any hope for an economic recovery will hinge on the government's ability to prop up shaky financial markets.

The effectiveness of a string of radical actions taken by the Fed, the Treasury Department and other agencies to stabilize markets "will be critical determinants of the timing and strength of the recovery," Bernanke said in testimony prepared for the Senate Budget Committee.

"We are better off moving aggressively today to solve our economic problems," he said.

"The alternative could be a prolonged episode of economic stagnation that would not only contribute to further deterioration in the fiscal situation, but would also imply lower output, employment and incomes for an extended period," he said.

The Fed chief found himself on the hot seat when lawmakers voiced concerns the government's new $30 billion lifeline for ailing insurance giant American International Group. The latest plan, announced Monday, marked the government's fourth effort to stabilize AIG.

Both Democratic and Republican lawmakers expressed skepticism over whether the action would work, said they were worried that more taxpayer money will be needed to rescue the company and demanded more accountability.

"I share your anger," Bernanke said. The government didn't really have a choice but to take the action because a collapse of AIG would have grave implications for the country's already fragile economic and financial health, he added.

"We're no better off," said Sen. Jim Bunning, a Kentucky Republican. "The bottom line: The Fed and the Treasury will leave the door open for more bailouts in the future."

President Obama's recent budget proposal projects an explosion of the budget deficit to $1.8 trillion, and a rise in the debt-to-GDP ratio to about 60% from 40%, the highest level since the early 1950s.

"All else equal, this is a development that all of us would have preferred to avoid," Bernanke said.

The president's recently enacted $787 billion stimulus package of increased federal spending and tax cuts should help revive moribund consumer demand, boost factory production over the next two years and "mitigate the overall loss of employment and income that would otherwise occur," Bernanke said.

However, the Fed chief warned that the timing and magnitude of the impact of the stimulus package is subject to "considerable uncertainty, reflecting both the state of economic knowledge and the unusual economic circumstances that we face."

The recession, now in its second year, is inflicting more damage to the economy daily as layoffs mount and companies cut production.

The economy contracted at a staggering 6.2% in the final three months of 2008, the worst showing in a quarter-century, and the Fed has said it will probably shrink during the first six months of this year. Recent economic barometers "show little sign of improvement," Bernanke said.

The nation's unemployment rate in January jumped to 7.6%, the highest in more than 16 years. And the number of newly laid-off people signing up for unemployment benefits has risen since mid-January, "suggesting that labor market conditions may have worsened further in recent weeks," Bernanke said. The government will release February unemployment data on Friday.

With jobs vanishing, nest eggs cracking and home values tanking, consumers have reined in their spending. That has forced companies to lay off workers, trim production and cut back in other ways. It's a vicious circle of negative forces that feed on each other, deepening the recession.

In back-to-back appearances on Capitol Hill last week, Bernanke planted a seed of hope that the recession could end this year if the government was successful in turning around wobbly financial markets. But the Fed chief didn't repeat that remark in Tuesday's testimony.

Bernanke said the government has made some progress on the financial front since last fall, but he told lawmakers that more needs to be done.

The Obama administration has revamped a $700 billion financial bailout program aimed at strengthening banks, but has said additional money could be needed.

Obama's first budget holds out the possibility of spending $250 billion more for additional financial industry rescue efforts.

"Whether further funds will be needed depends on the results of the current (stress tests) of banks, the evolution of the economy and other factors," Bernanke said.