(Agencies)
Updated: 2008-02-15 08:40

WASHINGTON -- Using words like "sluggish" and "deteriorated," Federal Reserve Chairman Ben Bernanke gave a starkly pessimistic assessment of the nation's economy on Thursday and signaled that the Fed will cut interest rate cuts further if needed to combat the adverse effects of a prolonged housing slump and a severe credit crisis.

US Federal Reserve chairman Ben Bernanke, seen here in January 2008, said Thursday he sees "a period of sluggish growth" followed by improvement on interest rate cuts and a stimulus plan, and kept the door open to further cuts. [Agencies]

Both Bernanke and Treasury Secretary Henry Paulson told a congressional hearing that the economy could still avert a full-blown recession, but Democrats said they believed the government should be doing much more to help millions of Americans cope with a threatened tidal wave of mortgage foreclosures.

Bernanke told the Senate Banking Committee the serious housing slump and a credit crisis triggered by rising defaults in subprime mortgages had greatly strained the economy.

"The outlook for the economy has worsened in recent months and the downside risks to growth have increased," Bernanke told the committee. "To date, the largest economic effects of the financial turmoil appear to have been on the housing market, which, as you know, has deteriorated significantly over the past two years or so."

Bernanke noted that hiring has slowed with job creation falling by 17,000 in January, the first such setback in more than four years. He said the weaker labor market along with recent declines in stock prices and declining home prices were likely to be a drag on consumer confidence going forward.

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The Fed chief told senators the "virtual shutdown" of the market for subprime mortgages given to people with blemished credit histories or low incomes -- and a reluctance by skittish lenders to make "jumbo" home loans exceeding $417,000 -- have aggravated problems in the housing market. "Further cuts in homebuilding and in related activities are likely," he said.

Bernanke said that in his own economic forecast he did not predict a recession but a period of sluggish growth "followed by a somewhat stronger pace of growth starting later this year" as the impacts of the Fed's rate cuts and the $168 billion economic stimulus package of tax rebates begin to be felt.

However, he also said there were significant downside risks ranging from the threat that the housing slide could become even more severe, the job market could deteriorate more than currently expected or that the credit squeeze will intensify. He said the Fed would be monitoring the economy closely and would "act in a timely manner as needed to support growth and provide adequate insurance against downside risks."

On Wall Street, Bernanke's comments pushed stocks lower. The Dow Jones industrials closed down 175.26 points at 12,376.98.

Private economists said they viewed Bernanke's sober assessment as a clear signal that the Fed, which cut interest rates by 1.25 percentage points in two moves in January, is prepared to cut rates further.

Brian Bethune, an economist at the private forecasting firm Global Insight, said he looked for bold half-point cuts at the Fed's next two regular meetings on March 18 and April 30. He said that what came out "loud and clear" from Bernanke's testimony was an increased concern about the stresses to the financial system from the credit crisis.

While saying that housing represented the greatest threat to the economy, Paulson, who testified along with Bernanke and Christopher Cox, chairman of the Securities and Exchange Commission, said he did not believe the economy would fall into a recession. He said the administration was working now to make ensure the government checks ranging from $300 to $1,200 were sent out without delay starting in May.

That stimulus package, which Congress passed last week, is expected to give the economy a sizable jolt in the second half of this year although many economists believe it will be too late to keep the economy from recording two consecutive quarters of negative economic output, the classic definition of a recession.

Pressed to say what more the administration plans to do, especially in dealing with a threatened wave of mortgage foreclosures, Paulson said he continued to look for good ideas but at the moment did not see the need to do any more than such current efforts as encouraging the mortgage industry to freeze rates on some subprime mortgages for five years and offering a 30-day reprieve on foreclosures for homeowners seriously behind on their payments to give them time to try to work out a loan modification with their lenders.

But a group of Senate Democrats said those efforts fell far short of what is needed. They announced outside of the hearing that they were introducing a second stimulus measure that would have a variety of initiatives to help stem foreclosures including providing $4 billion in new community development grants to purchase and rehabilitate foreclosed properties.

"If we really want to tackle the economic problems the country is facing, we must address the housing crisis that got us here," said Sen. Charles Schumer, D-N.Y., a supporter of the new stimulus measures.

Senate Banking Committee Chairman Chris Dodd, D-Conn., told reporters after the hearing that he planned to explore a proposal to create a Homeownership Preservation Corp. that would buy mortgages at steep discounts from mortgage firms and banks and then rework the loans based on the reduced value of the properties, making the payments more manageable.

Dodd told Bernanke, Paulson and Cox that he believed all three of their agencies needed to do more to help deal with what he called a "crisis of confidence."

Sen. Robert Menendez, D-N.J., criticized policymakers for what he believed was a too slow response to the housing crisis. "We count on those at the top ... to sound an alarm," during a crisis, he said. Instead, "what we got was a snooze button ... we've been behind the curve."

Paulson said that in the final three months of last year, more than 470,000 homeowners got help from companies servicing their mortgages and almost 30 percent of those received a loan modification. He insisted the administration was working hard to help, and called the problems facing some struggling homeowners "heartrending."