Bernanke Warns Of 'Grave Threat' To U.S. Economy
Fed Chairman Pushes Bailout, Citing Worsening Credit Market

By Michael A. Fletcher and Neil Irwin
Washington Post Staff Writers
Thursday, September 25, 2008

Key supports that have bolstered the U.S. economy through the housing collapse and financial crisis appear to be weakening, making it all the more urgent that Congress quickly approve a Bush administration proposal intended to keep the crisis from spreading, Federal Reserve Chairman Ben S. Bernanke told lawmakers yesterday.

Testifying before the Joint Economic Committee, Bernanke warned lawmakers of the "grave threat" posed by deteriorating lending conditions, which could severely hamstring the economy in the near future. Just yesterday, the interest rates banks charge each other for short-term loans skyrocketed, showing a deepening of the credit crisis.

Solid consumer spending, business investment and exports have propped up the U.S. economy for the past year, but there are signs that all three could be weakening.

Bernanke called the proposal for massive government purchases of shaky mortgage assets essential to preventing the financial crisis from clogging the flow of credit and further slowing the economy. His comments came as some lawmakers expressed deep skepticism over the plan, which they said would help big banks at the expense of ordinary Americans.

Peter R. Orszag, the director of the Congressional Budget Office, testified yesterday that the proposed bailout could actually worsen the crisis by revealing more troubled assets on companies' books.

But Bernanke warned, "The intensification of financial stress in recent weeks, which will make lenders still more cautious about extending credit to households and business, could prove a significant further drag on growth," he said.

He pointed to other ominous economic signs, including slowdowns in household spending and the sharp drop-off in motor vehicle sales.

Bernanke noted that despite some signs of stabilization in home sales, fewer new homes are being started, which could further slow construction-related businesses. Although business investment held up through the first part of the year, he said "a range of factors, including weakening fundamentals and constraints on credit, are likely to result in a considerable slowdown in the construction of commercial and office buildings" in the coming months. He noted that spending on business equipment and software also appeared poised to fall.

International trade has been a big driver of economic growth through the first part of the year, he said, but that appears set to dissipate amid a slowing global economy and deterioration in world financial markets.

Bernanke's pessimism was shared by other economists who worry that the economy, which has limped along for the past year despite upheavals in the housing and financial markets, could be on the verge of a pronounced slowdown, particularly if credit tightens further.

"We're worried, very worried," said David John, a senior fellow at the Heritage Foundation. "There is a significant amount of corporate debt that is going to come due on Sept. 30, [the end of the quarter]. The signs in the market -- interbank lending rates, high Treasury bill spreads -- indicate that it is going to be very difficult to roll over that debt much less get any new operating debt."

In a letter sent to members of Congress yesterday, Thomas R. Kuhn, president of the Edison Electric Institute, a lobbying group for public utilities, warned that short-term borrowing costs to utilities had already increased substantially. "If the current financial crisis is not resolved quickly, financial pressures on utilities will intensify sharply, resulting in higher costs to our customers" and possibly compromising service, he said.

Tightening credit conditions are already affecting some consumers and businesses. A survey released earlier this week by the National Small Business Association found that more small businesses were feeling the pressure from the credit crunch. Two-thirds of the 250 member firms surveyed said they were being affected, compared with the half that said they felt the effects in a similar survey this spring.

A July survey by the Federal Reserve found that 60 percent of banks had tightened lending standards on commercial and industrial loans for medium- and large-size firms. Credit had gotten even tighter for small firms, as the survey found that 65 percent of banks had tightened standards for them, up significantly from three months earlier.

Nancy Floyd, founder and managing director of Nth Power, a California venture capital fund that provides start-up money for new firms focusing on energy technology, said she had not seen any change in equity investments. But bank loans for fledgling businesses could be another matter, she said.

The disarray in the credit markets is exacerbating unemployment in states already reeling from the housing downturn. In Florida, where home prices have nose-dived after doubling from 2000 to 2006, unemployment was 6.5 percent in August, well above the 6.1 percent national average and 2.3 percentage points higher than it was a year earlier.

"The increase from the unemployment rate was the mirror image of the fact that Florida was the leading state in job growth during the housing boom," said David Denslow, a University of Florida economist. "As it unraveled, it hurt us worse than it did other states."

Now the fallout from the housing downturn is being compounded by the credit crunch, leading to more unemployment, which further weakens the housing market.

"This is the land of the entrepreneur. We have all of these small businesses but now their access to the credit market has just dried up," said Bob Forsythe, dean of the University of South Florida's College of Business Administration. "Now some firms can't hold their ground, and they are going out of business."

Air taxi pioneer DayJet Services, based in Boca Raton, Fla., ceased operations suddenly last week, a consequence of its inability to arrange new financing, the company said. The shutdown eliminated more than 150 jobs.

In a message posted on the company's Web site, DayJet founder Ed Iacobucci said that his company's business model of flying business people relatively short distances in personal-sized, fuel-efficient planes was working. But the company just ran out of money. "Regrettably, without access to growth capital, we have no choice but to discontinue operations," he said.

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