Fed Throws More Cold Water On Economy

Federal Reserve Chairman Ben Bernanke told Congress Tuesday the fragile economy is facing "numerous difficulties" despite the Fed's aggressive interest rate reductions and other fortifying steps.

At the same time, Bernanke, testifying before the Senate Banking Committee, sounded another warning that rising prices for energy and food are elevating inflation risks. This problem looms even as officials try to cope with persistent strains in financial markets, rising joblessness and housing problems.

The situation, he said, poses "significant challenges" for Fed policymakers as they try to chart the best course for keeping the economy growing, while making sure inflation doesn't dangerously flare up. All the economy's problems, including slumping home values, which threaten to make people feel less wealthy and less inclined to spend in the months ahead, represent "significant downside risks" to economic growth.

Over the rest of this year, the economy will grow "appreciably below its trend rate" mostly because of continued weakness in housing markets, high energy prices and tight credit conditions.

As Bernanke spoke, President George W. Bush addressed the economy at a press conference Tuesday.

The president urged lawmakers to move quickly in putting into force legislation designed to help prop up mortgage giants Fannie Mae and Freddie Mac while declaring the U.S. financial system to be "basically sound."

On Wall Street, stocks slumped. The Dow Jones industrials were down around 50 points, after suffering steeper losses earlier in the morning.

The day's other big financial news was General Motors Corp. announcing it will lay off salaried workers, cut truck production, suspend its dividend and borrow $2 billion to $3 billion to weather a severe downturn in the U.S. market.

GM said the moves will raise $15 billion to help cover losses and turn around its North American operations, including $10 billion from internal cost-cutting and $5 billion from selling some assets and borrowing against others.

"In short, our plan is not a plan to survive. It is a plan to win," GM Chairman and CEO Rick Wagoner said in a broadcast to employees.

Bernanke's testimony comes just two days after the Fed and the Treasury Department came to the rescue of mortgage giants Fannie Mae and Freddie Mac, offering to throw them a financial lifeline.

The Fed chief was later joined by Treasury Secretary Henry Paulson and Securities and Exchange Commission Chairman Chris Cox, who were summoned to detail the rescue plan.

The two companies hold or guarantee more than $5 trillion in mortgages - almost half of the nation's total. The Bush administration is asking Congress to temporarily increase lines of credit to Fannie and Freddie and to let the government buy their stock. The Fed has offered to let the companies draw emergency loans.

The pledges of aid have raised concerns about the government's role in such financial problems and the risk to taxpayers.

Sen. Christopher J. Dodd, D-Conn., the Banking Committee chairman, called the plan "unprecedented."

Dodd said the rescue raises serious questions "about the nature of the economic crisis facing our nation, about the ability of these proposals to address this crisis effectively, and about the burden that the American taxpayer potentially is being asked to carry."

Paulson said that if the government extends any financial backing to the two institutions it will be done "under terms and conditions that protect the U.S. taxpayer." He didn't provide details.

Sen. Richard C. Shelby of Alabama, the panel's senior Republican, cautioned, "I fear that we're sitting on a financial powder keg."

On the economic front, inflation has remained high and "seems likely to move temporarily higher in the near term," Bernanke warned.

Indeed, before Bernanke delivered his twice-a-year comprehensive economic assessment to Congress, the Labor Department reported wholesale prices jumped 1.8 percent in June. That left inflation rising over the past year at the fastest pace in more than a quarter-century.

"Given the high degree of uncertainty" about the Fed's economic outlook, Fed policymakers will need to carefully assess incoming information about inflation and economic growth, he said.

The Fed in June signaled an end to its nearly year long rate-cutting campaign because of growing concerns about inflation. Bernanke kept up his tough anti-inflation talk on Tuesday but stressed many other problems that could short circuit economic growth. He seemed to be keeping his options open in terms of rates. Given all the risky cross currents, economists believe the Fed will leave rates alone when they meet on Aug. 5.

Righting wobbly financial markets is key to getting the economy back on track, he said.

"In general, healthy economic growth depends on well-functioning financial markets," Bernanke said. "Consequently, helping the financial markets to return to more normal functioning will continue to be a top priority," he said.

But the heart of the economy's troubles is still housing, reports CBS News business correspondent Anthony Mason.

When asked by Sen. Robert Menendez, D-NJ, if he could predict when the housing market would reach rock bottom, Bernanke could not.

"I have to say there's uncertainty about the equilibrium level that house prices will reach."

Strengthening regulatory oversight of Fannie and Freddie, Bernanke said, is "job one." Congress is moving ahead on a broad housing rescue package that includes provisions to tighten regulation over the two companies. Bernanke said legislative efforts to help stabilize the housing market - the biggest threat to the economy - are of vital importance.

Bernanke, in the first day of back-to-back appearances on Capitol Hill, said investors are nervous in general because of the cloudy outlook for the economy and credit conditions, feeding a vicious cycle that can be hard to break.

"Many financial markets and institutions remain under considerable stress, in part because the outlook for the economy and thus for credit quality, remains uncertain."

The Fannie and Freddie troubles came on the heels of the failure of IndyMac, a big bank. "Its failure ... was inevitable," Bernanke said because the bank was weighted down by low-quality mortgages. "All banks are being challenged by credit conditions now," he said, adding that the Fed is keeping close tabs on the nation's banking sector.

And, earlier this year, a run on investment bank Bear Stearns pushed the company to the edge of bankruptcy and into a takeover by JPMorgan Chase, which was backed financially by the Fed. That was a controversial move that prompted critics to call it a government bailout, putting taxpayers money at risk.

Bernanke defended its decisions in the cases of Bear Stearns as well as Fannie and Freddie, and rebuffed claims that the government is helping Wall Street at the expense of Main Street. If problems aren't contained, they can ripple throughout the economy, hurting everyone, he said. "Financial stability is critical to economic stability."

The Fed, in new projections, now believes inflation will be higher this year than previously thought, with prices rising as high as 4.2 percent under one inflation measure.

Growth for the year will be sluggish - at best 1.6 percent growth - but not as bad as previously forecast, helped by the government's $168 billion stimulus, including rebates. The unemployment rate, which could rise as high as 5.7 percent this year, is the same as earlier projections.