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Bernanke says recession may tarry but banks to survive

  Federal Reserve Chairman Ben Bernanke warned on Tuesday the “severe” US recession could drag into next year, but he suggested big banks would survive the downturn without being nationalized, cheering markets.

Delivering a sombre assessment to lawmakers, Bernanke said the fast-shrinking economy risked entering a mutually reinforcing cycle of weak growth and financial market strain if the banking system were not stabilized.

“To break the adverse feedback loop, it is essential that we continue to complement fiscal stimulus with strong government action to stabilize financial institutions and financial markets,” he told the Senate Banking Committee. “If actions taken by the administration, the Congress, and the Federal Reserve are successful in restoring some measure of financial stability -- and only if that is the case, in my view -- there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery," he said.

Bernanke expressed faith that authorities were on the right path in taking time to fully diagnose the health of top US banks, with a vow to recapitalize them if needed. “If I thought the banks were irrevocably damaged, I would have a different view, but I do believe our major banks have significant franchise values,” he said. “There is no commitment by any means to never shut down a big bank, absolutely not, but I do believe that the major banks we have now can be stabilized.”

The US central bank chief’s steady assertions, over three-and-a-half hours of questioning, that banks retain value in spite of huge losses gave a lift to US stocks. In late afternoon, the blue chip Dow Jones industrial average was up 230 points, or 3.28%, after touching a 12-year low on Monday, hurt by fears that the government might have to nationalize banks. Concerns the government may need to nationalize US banks has weighed on US stocks, which hit a 12-year low on Monday.

The US government is moving into the second phase of a $700 billion program to strengthen financial institutions, and plans to invest in banks that need capital in return for preferred shares that could convert over time to common stock. “We are committed to ensuring the viability of all major financial institutions,” the Fed chief told lawmakers.

GLOBAL SLOWDOWN CRIMPING US GROWTH

Bernanke warned that another risk to the outlook was the global nature of the economic slowdown, which could sap US exports and harm financial conditions to a greater degree than currently expected. A slump in US exports as world growth slowed last year added to a deep pullback in consumer spending that steepened the downward slide in the US economy.

Bernanke said the Fed, which has dropped rates to nearly zero, would keep borrowing costs exceptionally low for some time and pledged to use “all available tools” to stimulate the economy and heal financial markets.

The Fed chairman did not discuss the prospect the central bank might purchase longer-term US government debt, marking his third consecutive appearance in which he has not mentioned the possibility, which was highlighted in a statement central bank policy-makers issued in late January.

“The Fed has decided put the Treasuries option on the back burner,” concluded Kevin Flanagan, a fixed income strategist at Morgan Stanley in Purchase, New York. The Fed chairman warned that the global nature of the economic slowdown could sap US exports and harm financial conditions to a greater degree than currently expected.

A slump in US exports as world growth slowed last year added to a deep pullback in consumer spending that steepened the downward slide in the US economy. He said the Fed, which has dropped rates to nearly zero, would keep borrowing costs exceptionally low for some time and pledged to use “all available tools” to stimulate the economy and heal financial markets.

Bernanke said the central bank had not ruled out buying longer-term US government bonds to drive down borrowing costs, but he said its immediate focus was on other steps to lower mortgage rates and spur consumer lending.

Some of the measures the central bank had already taken had helped ease tight conditions in some credit markets, he said. “Nevertheless, despite these favorable developments, significant stresses persist,” Bernanke said. (Reuters)