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Bernanke offers stark words as hopes dim for economy

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Fed Chairman Ben Bernanke said Tuesday that Congress should not cut spending significantly right now because it will impair economic recovery.

"The recovery is close to faltering."

Those are the words of Federal Reserve Board Chairman Ben Bernanke. You can’t get much closer to the R-word these days without just coming out and saying "recession."

Since this summer, forecasters have been gradually paring back their growth targets for the rest of the year and next. As they’ve whittled their forecasts, it's gotten much tougher to avoid calling for another economic downturn.

The latest assessment came from Bernanke, who told lawmakers on Capitol Hill Tuesday: “We need to make sure that the recovery continues and doesn’t drop back and that the unemployment rate continues to fall downward.”

Central bankers typically avoid warning of impending recessions for fear of creating a self-fulfilling prophecy. But private economists caution that the Fed is virtually powerless to do anything about financial turmoil in Europe, which is roiling global financial markets. More than a year after eurozone governments and policy makers began wrestling with a widening debt problem, there are no clear solutions.

On Tuesday, European finance ministers postponed a critical bailout payment to Greece until mid-November and were reportedly considering making European banks take bigger losses on Greek debt. The news sent European bank stocks tumbling further.

U.S. stocks endured another seesaw day before finishing largely higher.

 

"There seems little doubt that (Europe's debt problems) have hurt household and business confidence, and that they pose ongoing risks to growth," said Bernanke.

On Monday, Goldman Sachs economists trimmed their growth forecasts for Europe and told clients they expect the eurozone to fall into recession beginning in the fourth quarter and continue to flatline next year -- with full-year 2012 growth in gross domestic product of just 0.1 percent. Headwinds from Europe will slow U.S. GDP growth to just a half-percent, the Goldman economists warned.

"The European crisis threatens U.S. economic growth via tighter financial conditions, reduced credit availability, and weaker growth of U.S. exports to the region," the Goldman economists said. "This impact is likely to slow the U.S. economy to the edge of recession by early 2012."

Many private forecasters still say publicly that the U.S. economy will barely dodge a recession and grow slowly for some time without actually contracting. The hope is that the historic flood of cash engineered by the Fed eventually will provide enough of a boost to get companies hiring and consumers spending again.

But there are growing concerns that the money is not providing the stimulus called for in the Fed's economics textbooks. Much of the easy money is sitting on corporate balance sheets as big companies have stockpiled cash to weather another economic storm. That cash pile now makes up the biggest portion of their assets in almost 50 years.

Big companies have also figured out how to generate healthy profits without hiring more workers. That strong cash flow has helped support stock prices in the midst of a looming global financial panic.

But the credit markets -- the global river of money that companies use to raise cash by selling bonds -- are beginning to show signs of stress. One measure, the premium that weaker companies have to pay to access that credit, is now at levels that accompanied three previous recessions, according to John Lonski, chief economist at Moody's Investors Service.

"It's not guaranteed that we're going a have a recession," he said. "But the performance of the financial markets, especially the credit market, means we have to be leery of a renewed tightening of lending standards -- not only for companies but for consumers and small businesses -- that could choke off the struggling economic recovery."

Bankers insist they're eager to lend, but can't find enough creditworthy borrowers. But as the economic outlook grows dimmer, lenders typically raise their standards to offset the higher risk of loan defaults that accompany recessions.

The U.S. housing market, meanwhile, remains mired in the deepest recession since the 1930s. Many economists note that every recovery in modern times, including the postwar boom that followed the Great Depression, have included a housing market rebound. But tighter credit standards hold back a housing recovery now, according to Paul Dales, a senior economist with Capital Economics.

Dales notes that home buyers typically need a credit score of at least 700 to qualify for a conventional mortgage from Fannie Mae or Freddie Mac, compared with around 650 during the mid-2000s. He figures that increase has sidelined roughly 12 percent of households looking for a home mortgage.

Falling home prices have also discouraged potential buyers from owning a home. According to a recent survey by Trulia, a real estate website, the number of Americans who believe that owning a home was part of their American Dream fell to 70 percent from 77 percent in 2010. Dales figures that's the equivalent of nearly 8 million households.

"Even if the US economy were to strengthen suddenly, a long-lasting decline in the willingness of Americans to buy a home and a permanent deterioration in their ability to qualify for a mortgage will prevent a significant strengthening in housing demand," Dales said.

There are few sources of growth left to propel the recovery. Consumer spending continues to weaken now that job growth has stalled. Some 45 percent of those out of work have been unemployed for at least six months -- a level previously unseen in the six decades since World War II. The manufacturing sector, one of the few bright spots of the weak recovery, is faltering. And government spending, after a two-year boost of stimulus, appears ready to contract as deficit hawks in Washington enjoy strong political backing from voters.  

Though the current weak recovery appears to most people to be much shorter than past expansions, some economists note that the boom cycles of the last 30 years have been the exception to the historical rule.

According to the Economic Cycle Research Institute, an independent group that tracks business cycles, between 1799 and 1929, nearly 90 percent of U.S. expansions lasted three years, as did two of the three expansions between 1970 and 1981.

Last week, the ECRI notified clients that the U.S. economy was now tipping into recession.

"And there’s nothing that policy makers can do to head it off," the group said.

Here is an excerpt from today's Bernanke testimony:

Federal Reserve chairman Ben Bernanke discusses strategies in areas, such as housing and tax reform, that could provide more economic certainty.