Bernanke: No quick recovery

Fed chairman says policymakers now have 'tools' to fix financial crisis but that economy will take time to rebound.

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By Chris Isidore, CNNMoney.com senior writer

What should be at the top of the next president's economic agenda?
  • Solving the credit crunch
  • Creating new jobs
  • Reducing the deficit
  • Halting the housing meltdown
  • Cutting taxes
fed_chart_15.03.jpg
The Federal Reserve lowered its key short-term interest rate to 1.5% last week.

NEW YORK (CNNMoney.com) -- Federal Reserve Chairman Ben Bernanke warned in a speech Wednesday that the U.S. economy will take some time to recover - even if the credit markets return to normal soon.

Bernanke, speaking before the Economic Club of New York, said he believes the steps taken by the Treasury Department, the Fed and Congress in recent weeks provide policymakers with the "tools" they need to fix the recent crisis in financial and credit markets.

Among the steps he cited were the Treasury Department's planned investment of $250 billion in the nation's banks in return for equity stakes, the Fed's decision to lend to major businesses through the purchase of commercial paper and broader guarantees on bank deposits by the Federal Deposit Insurance Corp.

But those moves will not solve all the problems facing the economy immediately, he cautioned.

"Stabilization of the financial markets is a critical first step, but even if they stabilize as we hope they will, broader economic recovery will not happen right away," Bernanke said in his prepared remarks. "Economic activity had been decelerating even before the recent intensification of the crisis."

Bernanke warned that even with all the moves made by the Fed and Treasury, "credit markets will take some time to unfreeze." He also said the housing crisis will continue to be a drag on the economy but he also said that "the problem was much broader than subprime lending."

He said the desire to increase returns on investments by both U.S. and foreign investors resulted in "an underpricing of risk, excessive leverage, and the development of complex and opaque financial instruments" that fed into the crisis.

Slowdowns in consumer spending, business investment, and the job market all will cause further weakness in the economy, Bernanke noted. He added that exports, a source of strength in the past few quarters, are likely to fall off due to slowing economic activity worldwide.

Still, Bernanke expressed hope that the economy will bounce back and that the Fed and other regulators will be able to effectively address problems resulting from the continuing credit crisis.

"I am not suggesting the way forward will be easy, but I strongly believe that we now have the tools we need to respond with the necessary force to these challenges," he said.

U.S. stock markets, which were already down when Bernanke began his midday speech, headed lower after the Fed chairman concluded his remarks.

"It's not like he said anything we didn't know. But the fact that he's the Fed chairman makes it carry more weight," said Robert Brusca of FAO Economics. "It's going to be tough sledding, there's no doubt about it. How can we not be having a recession with everything that is happening?"

Later Wednesday afternoon the Fed published its so-called beige book, a monthly summary of economic conditions from the Fed's 12 regional district banks. The report showed economic weakness spreading across all 12 regions and to most sectors of the economy.

"No mechanism" to save Lehman

In a question-and-answer session following the speech, Bernanke said he is very concerned about the concept that some financial institutions are too big to fail and that he wants there to be limits on financial market concentration going forward.

"I don't want to see this country go to the point where we have six large banks and that's basically the credit market. We need to have...diversity," he said.

He said when a bank or other financial institution is assumed to be too big to fail, it causes market distortions and can encourage unduly risky decisions.

But he acknowledged there are now too many firms that are so large that their failures could pose a risk to the broader financial system.

Much of the crisis in the credit and financial markets started after Wall Street firm Lehman Brothers (LEHMQ) filed for bankruptcy on Sept. 15. Before that, many economists and Wall Street traders had assumed it also was too big to fail.

The Fed had previously kept Bear Stearns from filing for bankruptcy protection in March by agreeing to assume up to $29 billion in questionable mortgage assets so that JPMorgan Chase (JPM, Fortune 500) would purchase the firm.

And the day after the Lehman bankruptcy, the Fed offered $85 billion in loans to insurer AIG (AIG, Fortune 500) to keep it out of bankruptcy.

Bernanke said the Fed did not have the freedom to rescue Lehman the way it intervened in the Bear Stearns or AIG bailouts because there was little chance such assistance would be paid back, as required by the laws governing the central bank.

"Lehman was not allowed to fail in the sense there was some choice being made," he said in response to a question. "There was no mechanism, there was no option, there was no set of rules, there was no funding to allow us to address that situation. In this case...there simply was not enough collateral to support the lending."

Bernanke's speech comes a day after San Francisco Fed President Janet Yellen said that the "U.S. economy appears to be in a recession," a rare use of that word by a Fed official.

Even as Bernanke warned of dire consequences of the credit crisis when seeking congressional approval of the bailout legislation last month, he never described the economy as having already fallen into a recession. Bernanke did not address Yellen's comment during the speech and was not asked about it during the question-and-answer period.

Bernanke also did not provide any more clues in his speech as to whether the Fed would cut interest rates at the conclusion of a two-day meeting on Oct. 29.

The Fed and five other central banks around the world announced a coordinated rate cut on Oct. 8. The Fed's key interest rate is now 1.5% and many investors expect another cut at the end of this month.

In a speech the day before that cut, Bernanke said that in light of growing economic weakness, "the Federal Reserve will need to consider whether the current stance of policy remains appropriate." That was widely interpreted as a sign that the Fed would soon lower rates.

Bernanke did say he thought there were limits to how much rate cuts could do to stimulate the economy. That's the reason the Fed also supported the $700 billion Wall Street bailout package and pumping cash into the system through other non-traditional measures. To top of page

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