Fed chairman defends Bear Stearns deal, warns of recession

WASHINGTON — The Federal Reserve acted on behalf of Main Street, not Wall Street, when it prevented the collapse of investment bank Bear Stearns, Chairman Ben Bernanke told Congress on Wednesday.

Bernanke also urged Congress to pass legislation swiftly to aid homeowners threatened with foreclosure and acknowledged that "a recession is possible" in the first half of this year. He said he thought that the economy would bounce back in the second half of 2008.

Much of Wednesday's testimony before the Joint Economic Committee of Congress focused on the Fed's unprecedented March 16 move to broker the sale of Bear Stearns to JP Morgan Chase, with taxpayers providing a $29 billion loan via the Fed to make it happen.

The Fed has long regulated commercial banks but has limited authority over investment banks, which aren't subject to the same scrutiny and enjoy more liberal capital requirements. When it announced the Bear Stearns sale, the Fed also said that it would provide emergency lending temporarily to investment banks and other financial players in a bid to calm jittery markets.

In his first public remarks since the controversial sale, the usually reserved Bernanke bristled at the suggestion by some Democrats that the Fed had bailed out a Wall Street bank but was unwilling to do the same for taxpayers who're behind on their mortgage payments.

"We did not bail out Bear Stearns. Bear Stearns' shareholders took a very significant loss. An 85-year-old company lost its independence and became acquired by another firm. I don't think any company is interested in repeating the experience of Bear Stearns," the Fed chairman said, his voice rising. "We did what we did because we felt it was necessary to preserve the integrity and viability of the financial system, which in turn is critical for the health of the economy."

The Fed, he continued, sought to prevent a bank failure that could have sparked a domino effect. Avoiding this outcome helped anyone who's looking to buy a home or refinance a mortgage, or any business owner in need of capital to expand operations, while protecting millions of Americans whose retirement savings are invested in the stock market, he said.

"Always in my mind was, what was the best thing for the American public. That's why we took that action, and I believe that was the benefit of that action, not to help individual Wall Street people," Bernanke said.

The Fed chairman revealed that since he began emergency lending to investment banks two weeks ago, he's worked closely with the Securities and Exchange Commission to examine the books of giant investment banks to ensure that another collapse isn't lurking.

"Since we've begun lending to dealers, including the remaining investment banks, we've put examiners on the ground in those firms. And we've established off-site teams," he said. "We want to be sure that any lending we do to investment banks will be done on an appropriately sound basis."

Bear Stearns had adequate capital reserves but lost the confidence of investors, who bolted, Bernanke said. He added that other investment banks have been told to increase the amount of money they hold in reserve and take other steps to guard against a similar loss of investor confidence.

"I certainly hope, and do not expect, a repeat of this episode. But the future is uncertain and we'll obviously have to keep monitoring what's happening," he testified.

Bernanke refused to endorse any of the competing bills to help struggling homeowners. That led Sen. Edward Kennedy, D-Mass., to berate the Fed chairman for refusing to take sides and offer a solution.

Bernanke did stress, however, that the U.S. economy's recovery still hangs on the ability to stop the slide in the housing market.

"If the housing market begins to stabilize — as we expect it will later this year and next year — there will be more confidence in the market about the value of mortgages and fewer write-downs," he said. "So I think that will go a long way to restoring confidence in financial markets and create more lending, but I can't, in any seriousness, tell you when that is going to happen."

He offered a bleak assessment of the near-term economic outlook, however.

"It now appears likely that real gross domestic product will not grow much, if at all, over the first half of 2008 and could even contract slightly," he said. However, he added that "uncertainty attending this forecast is quite high, and the risks remain to the downside."

Bernanke said that "a recession is possible" but he thinks it unlikely because of the Fed's aggressive interest-rate cuts and the pending economic-stimulus plan passed by Congress and President Bush, which is designed to jolt the economy back to life.

By next year, Bernanke said, growth should return to or above a "sustainable pace."


Bernanke's opening statement