Bernanke Backs Calls for Quick Action

The Fed chairman endorses "substantive" rate cuts and congressional efforts for rapid economic stimulus. Critics say it's too little, too late

Federal Reserve Chairman Ben Bernanke threw his support behind quick and temporary tax breaks, combined with the possibility of "substantive" rate cuts, in testimony before Congress. But he did little to reassure Wall Street the central bank has the wherewithal to steer the U.S. economy out of a possible recession.

Stocks sold off under waves of bad news, including a stunning $9.9 billion fourth-quarter loss posted by Merrill Lynch (MER) and a 25% drop in 2007 housing starts. The Dow Jones industrial average closed down 306.95 points, or 2.46%; the Standard & Poor's 500-stock index dropped 39.95 points, or 2.91%.

The Fed has already cut its short-term interest rate by a percentage point, to 4.25%, since September. Bernanke, testifying on Jan. 17 before the House Budget Committee, indicated the central bank will act faster and make deeper cuts, possibly lowering the federal funds rate by another half a percentage point at the board's next meeting Jan. 29-30. But many investors think it's too little, too late, and they are losing confidence that the U.S. can dodge a recession.

Economic Stimulus Needed ASAP

"I think that the markets are in panic mode, and there is the risk that sentiment becomes so bad that we effectively talk ourselves into recession," says Joseph LaVorgna, the chief U.S. economist for Global Markets Research.

If Congress wants to help the economy, Bernanke said, it needs to act quickly. He supported some proposals for investment tax credits or accelerated depreciation that will give an immediate boost to corporate or consumer spending without firing up inflation as the economy recovers. "Stimulus that comes too late will not help support economic activity in the near term, and it could be economically destabilizing if it comes at a time when growth is already improving," he testified.

A White House spokesman said President George W. Bush also supports some form of temporary relief, but was elusive on the details. Lawmakers are mulling over a stimulus package that would inject roughly $100 billion into the economy through a variety of tax breaks, rebates, extended unemployment benefits, temporary business expensing, or depreciation.

Admits Central Bank Erred

Bernanke's comments should help speed along legislation, said Senator Charles Schumer (D-N.Y.), chairman of the Joint Economic Committee, in a statement released after the hearings. "Chairman Bernanke's explicit endorsement of a stimulus package and his implicit judgment that extending Bush's tax cuts would not help create short-term economic stimulus…means that this could all [gel] shortly."

Bernanke now admits falling home prices, higher-than-expected energy costs, and a weak stock performance are expected to drag down U.S. growth this year. Consumer spending is falling, and the unemployment rate edged up by a "disappointing" 0.3 percentage points in December, to 5.0%, while new jobs declined. The Fed chairman acknowledged the central bank has "consistently underestimated" the impact of rising oil prices and other commodities on the U.S. economy.

One problem Bernanke may not be able to overcome: He lacks the swagger and devout following of his predecessor, Alan Greenspan. Combined with worse-than-expected earnings and economic data, the markets are having a tough time taking Bernanke at his word.

"He doesn't have the street cred yet," said David Wyss, chief economist of Standard & Poor's, which like BusinessWeek is owned by The McGraw-Hill Companies (MHP). "Bernanke is still saying he thinks the U.S. will escape recession; most people on the Street think we are already in one. Maybe nobody's sure Bernanke is wrong, but the markets think he is."

Before it's here, it's on the Bloomberg Terminal.