Federal Reserve Chairman Ben Bernanke said Tuesday the stimulus package being crafted by President-elect Barack Obama and Congress could provide a "significant boost" to the sinking economy. But he warned that such a recovery won't last unless other steps are taken to stabilize the shaky financial system.
Although Bernanke has previously endorsed the notion for a fresh round of government stimulus to lift the country out of a recession, it marked the first time the Fed chief has referenced the roughly $800 billion recovery plan now being worked on by Obama, who takes office next week. Obama envisions a blend of tax cuts and increased government spending, including on big public works projects, to make up the stimulus plan.
Bernanke, who didn't weigh in on the details of the evolving package, made clear that such a recovery plan was needed as part of a broader, multi-pronged government response to combat the worst financial crisis to hit the U.S. and the global economy since the 1930s.
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"The incoming administration and the Congress are currently discussing a substantial fiscal package that, if enacted, could provide a significant boost to economic activity," Bernanke said in a speech to the London School of Economics.
"In my view, however, fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system," he warned. "History demonstrates conclusively that a modern economy cannot grow if its financial system is not operating effectively."
To help on that front, the Fed is loaning out billions to financial companies and buying mounds of companies' debt to help bust through the debilitating credit clog. And the Treasury Department is overseeing a $700 financial bailout program that has pledged to inject $250 billion into banks in return for partial government ownership. Some money from the bailout pot also is being used to guarantee against possible losses from risky assets held by Citigroup Inc.
Bernanke said "more capital injections and guarantees may become necessary" to stabilize financial markets and spur more lending. If Obama's incoming Treasury secretary Timothy Geithner decides to remove toxic assets from financial institutions' balance sheets — the original but abandoned strategy under the $700 billion bailout — Bernanke suggested some options to do that.
Public purchases of the troubled assets are one way to go, he said. Another option is to provide asset guarantees under which the government would agree to absorb — presumably in exchange for warrants or some other form of compensation — part of the prospective losses on specified portfolios of rotten assets held by banks. Yet another approach would be to set up and capitalize so-called "bad banks," which would buy assets from the financial institutions in exchange for cash and equity in the bad bank.
Some Americans and some on Capitol Hill have been upset about Treasury's management of the $700 billion program, which has provided aid to financial companies and others on Wall Street — some of whom are blamed for getting the country into economic the mess in the first place — while other struggling industries get little or no assistance.
Bernanke said he understands this concern, but added: "This disparate treatment, unappealing as it is, appears unavoidable."
The United States' economic system is critically dependent on the free-flow of credit, Bernanke said. It is like the economy's oxygen. As it has been cut off, the economy has sunk deeper into recession, taking Americans' jobs with it.
Washington policymakers, Bernanke said, "must therefore do what they can to communicate to their constituencies why financial stabilization is essential for economic recovery and is therefore in the broader public interest."
Obama's political skills will be put to a high-stakes test with Congress as he seeks assess to the second half of the $700 billion bailout pot. Congress has a 15-day deadline to reject the request, which President George W. Bush made on Obama's behalf on Monday.
To cushion fallout from the recession, the Fed in December slashed its key rate to an all-time low of between zero and 0.25 percent. The Fed signaled that it would keep rates at that level for some time and pledged to use unconventional tools to revive the economy. One such tool Bernanke again mentioned is the possibility of the Fed buying longer-term Treasury securities.
The central bank will meet later this month to assess economic and financial conditions.
Even as the U.S. battles the current crisis, it must move to prevent future ones. To be effective, international cooperation is needed, Bernanke said.
"A clear lesson of the recent period is that the world is too interconnected for nations to go it alone in their economic, financial and regulatory policies," Bernanke said. "International cooperation is thus essential if we are to address the crisis successfully and provide the basis for a healthy, sustained recovery."
In time, the global economy will recover from the current crisis, "but the timing and strength of the recovery are highly uncertain," he added.