WASHINGTON - Federal Reserve Chairman Ben Bernanke warned on Tuesday the "severe" US recession may drag into 2010 unless the government succeeds in stabilizing the banking system and financial markets with strong action.
Delivering a somber assessment to lawmakers, Bernanke said the fast-shrinking economy risked entering a mutually reinforcing cycle of weak growth and financial market strain.
"To break the adverse feedback loop, it is essential that we continue to complement fiscal stimulus with strong government action to stabilize financial institutions and financial markets," he told the Senate Banking Committee.
"If actions taken by the administration, the Congress, and the Federal Reserve are successful in restoring some measure of financial stability -- and only if that is the case, in my view -- there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery," he said.
Financial markets largely ignored the testimony. US stocks cut early gains on a report that consumer confidence sank to a record low in February, but later turned higher on bargain hunting.
Bernanke said "stress tests" US regulators are readying for the nation's largest banks aim to judge whether they can keep lending even under strained economic scenarios.
"The purpose of these assessments that we're going to do going forward is to make sure that banks have enough capital, not only to be well-capitalized in what we expect to be the weak conditions that we will see in the next year, but even under conditions that are weaker than expected," he said.
He said regulators wanted "to ensure that even in a bad scenario, banks will have enough capital, including enough common equity, to meet their obligations to lend."
Concerns the government may need to nationalize US banks has weighed on US stocks, which hit a 12-year low on Monday.
The US government is moving into the second phase of a $700 billion program to strengthen financial institutions, and plans to invest in banks that need capital in return for preferred shares that could convert over time to common stock.
"We are committed to ensuring the viability of all major financial institutions," the Fed chief told lawmakers.
Global slowdown crimping US growth
Bernanke warned that another risk to the outlook was the global nature of the economic slowdown, which could sap US exports and harm financial conditions to a greater degree than currently expected.
A slump in US exports as world growth slowed last year added to a deep pullback in consumer spending that steepened the downward slide in the US economy.
Bernanke said the Fed, which has dropped rates to nearly zero, would keep borrowing costs exceptionally low for some time and pledged to use "all available tools" to stimulate the economy and heal financial markets.
The Fed chairman did not discuss the prospect the central bank might purchase longer-term US government debt, marking his third consecutive appearance in which he has not mentioned the possibility, which was highlighted in a statement central bank policy-makers issued in late January.
"The Fed has decided put the Treasuries option on the back burner," concluded Kevin Flanagan, a fixed income strategist at Morgan Stanley in Purchase, New York.
Bernanke noted that an ongoing Fed program to buy mortgage finance agency debt and mortgage-backed securities had helped move mortgage rates lower by nearly one percentage point since it was announced in November.
Steps the central bank has taken have helped restore some stability in certain areas of financial markets, the Fed chairman said, citing reduced strains in short-term funding markets, improved commercial paper market conditions and declines in corporate risk spreads.
"Nevertheless, despite these favorable developments, significant stresses persist," Bernanke said. "Notably, most securitization markets remain shut, other than for conforming mortgages, and some financial institutions remain under pressure."