Bernanke: U.S. economy facing ‘difficulties’

updated 1:24 p.m. ET July 15, 2008

WASHINGTON - Federal Reserve Chairman Ben Bernanke told Congress Tuesday the fragile economy is facing “numerous difficulties” despite the Fed’s aggressive interest rate reductions and other fortifying steps.

At the same time, Bernanke, testifying before the Senate Banking Committee, sounded another warning that rising prices for energy and food are elevating inflation risks. This problem looms even as officials try to cope with persistent strains in financial markets, rising joblessness and housing problems.

The situation, he said, poses “significant challenges” for Fed policymakers as they try to chart the best course for keeping the economy growing, while making sure inflation doesn’t dangerously flare up. All the economy’s problems — including slumping home values, which threaten to make people feel less wealthy and less inclined to spend in the months ahead — represent “significant downside risks” to economic growth.

Over the rest of this year, the economy will grow “appreciably below its trend rate” mostly because of continued weakness in housing markets, high energy prices and tight credit conditions.

On Wall Street, stocks slumped. The Dow Jones industrials were down around 50 points, after suffering steeper losses earlier in the morning.

Bernanke’s testimony comes just two days after the Fed and the Treasury Department came to the rescue of mortgage giants Fannie Mae and Freddie Mac, offering to throw them a financial lifeline.

The Fed chief was later joined by Treasury Secretary Henry Paulson and Securities and Exchange Commission Chairman Chris Cox, who were summoned to detail the rescue plan.

The two companies hold or guarantee more than $5 trillion in mortgages — almost half of the nation’s total. The Bush administration is asking Congress to temporarily increase lines of credit to Fannie and Freddie and to let the government buy their stock. The Fed has offered to let the companies draw emergency loans.

The pledges of aid have raised concerns about the government’s role in such financial problems and the risk to taxpayers.

Sen. Christopher J. Dodd, D-Conn., the Banking Committee chairman, called the plan “unprecedented.”

Dodd said the rescue raises serious questions “about the nature of the economic crisis facing our nation, about the ability of these proposals to address this crisis effectively, and about the burden that the American taxpayer potentially is being asked to carry.”

Paulson said that if the government extends any financial backing to the two institutions it will be done “under terms and conditions that protect the U.S. taxpayer.” He didn’t provide details. “This is a backup facility that hopefully it will never be used,” Paulson said. The Treasury chief said he hoped that the pledge itself would help to boost eroding investor confidence in the companies.

Sen. Richard C. Shelby of Alabama, the panel’s senior Republican, cautioned, “I fear that we’re sitting on a financial powder keg.” Officials may envision never using the powers, Shelby added, but “this is not an empty gesture.... what if they did?”

On the economic front, inflation has remained high and “seems likely to move temporarily higher in the near term,” Bernanke warned.

Indeed, before Bernanke delivered his twice-a-year comprehensive economic assessment to Congress, the Labor Department reported wholesale prices jumped 1.8 percent in June. That left inflation rising over the past year at the fastest pace in more than a quarter-century.

“Given the high degree of uncertainty” about the Fed’s economic outlook, Fed policymakers will need to carefully assess incoming information about inflation and economic growth, he said.

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