Fed chief Bernanke defends Bear Stearns deal

By Sue Kirchhoff, USA TODAY
WASHINGTON — Federal Reserve Chairman Ben Bernanke said Wednesday that the economy could fall into recession, as housing and financial markets remain distressed despite dramatic Fed interest rate cuts and emergency lending.
"It now appears likely that (the economy) will not grow much, if at all, over the first half of 2008 and could even contract slightly," Bernanke told the Joint Economic Committee. He expects activity to pick up into 2009 but warned that major risks remain. "We are fighting against the wind," Bernanke said.

Bernanke staunchly defended the Fed's decision last month to broker JPMorgan Chase's (JPM) takeover of investment bank Bear Stearns, (BSC) including approval of a loan backed by $30 billion of Bear Stearns assets.


MORTGAGE DEMAND DROPS: Interest rates remain below 6%.
PREPARED TESTIMONY: Text of Bernanke's remarks.

Given "exceptional pressures" on the global economy and financial system, the damage caused by a potential Bear Stearns default could have been "severe and extremely difficult to contain," Bernanke said. He stressed that the move wasn't a bailout but an effort to preserve the integrity of the overall financial system.

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The Fed, which doesn't directly regulate Bear Stearns, had just 24 hours' notice that the nation's No. 5 investment bank could file for bankruptcy. A Bear Stearns default could have sparked a "chaotic unwinding" affecting the overall economy, Bernanke said.

"Perhaps in a more robust environment we would have made a different choice," Bernanke said. "The financing … has never happened before, and I hope it never happens again."

Even though the economy is slowing, inflation — boosted by high energy and food prices — remains a concern and constraint for the central bank. The Fed has sliced a key interest rate to 2.25% from 5.25% since September. Bernanke did not spell out the direction of policy, though his downbeat tone suggests the Fed is likely not done cutting rates.

Brian Bethune of economic consulting firm Global Insight expects the Fed to cut its target for short-term rates into midsummer.

The economy grew at an anemic 0.6% annual pace in the final quarter of 2007. Employers are shedding jobs, consumer confidence and spending have been shaken, and lenders have pulled back.

Bernanke said the extraordinary Fed moves — including invoking Depression-era authority to lend to investment banks — had helped but that financial markets are still under "considerable stress."

He said Congress should act to help stabilize the housing market. He rejected the notion that the Fed had helped Wall Street but ignored Main Street, saying interest rate cuts had at least offset some of the headwinds from financial markets. Bernanke said a company hired by the Fed to oversee Bear Stearns assets has said the Fed should be able to get its money back.