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Bernanke, Paulson in the line of fire

WASHINGTON — WASHINGTON -- With the credit markets once again deteriorating, the nation's two top economic policymakers acknowledged yesterday that the outlook for the economy had worsened, as both came under criticism for being overtaken by events and failing to act boldly enough.

In testimony to Congress, Ben S. Bernanke, chairman of the Federal Reserve, signaled that the Fed was ready to reduce interest rates yet again, pointing out that problems in housing and mortgage-related markets had spread more widely and proved more intractable than he predicted three months ago.

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His sobering assessment was echoed by Treasury Secretary Henry M. Paulson Jr., who appeared with him. Both continued to avoid predicting a recession but said they were scaling back the more optimistic forecasts they had issued in November.

Ethan S. Harris, chief U.S. economist for Lehman Brothers, said that both policymakers had "come clean" about the economy's problems but that investors were not impressed.

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Stock prices, which normally rally when the Fed hints it will lower borrowing costs, tumbled instead. The Dow Jones industrial average dropped 175 points, or 1.4 percent; broader stock indexes dropped by similar amounts.

Anxiety is escalating among institutional lenders and major borrowers, as the panic over soaring default rates on subprime mortgages that began last summer continues to spread, freezing up credit for municipalities, hospitals, student loans and even investment funds holding the most conservative bonds.

On Capitol Hill, the economic policymakers found themselves in the line of fire. Democratic Sen. Robert Menendez of New Jersey accused Bernanke and Paulson of having "hit the snooze button."

Sen. Christopher J. Dodd, the Connecticut Democrat who chairs the banking committee, told reporters after the hearing, "It just seems as if they aren't as concerned about the magnitude of the problem."

Testifying before the committee, Bernanke said he still expected the economy to grow at a "sluggish" pace over the next few months and to pick up speed later in the year. But, he said, "the downside risks to growth have increased," noting that spiraling losses in home mortgages have dragged down the credit markets and shaken the broader economy.

While trying to be optimistic, Paulson said that the administration's forecast "would be less, but I do believe we'll keep growing."

Many Wall Street economic forecasters, however, are estimating that the risks of a recession are at least 50-50, and a growing number of analysts contend that an economic contraction may have begun.

The Fed has reduced its benchmark interest rate, called the federal funds rate, five times since September, including two cuts within eight days last month. The rate has fallen to 3 percent; as recently as late summer, it had been 5.25 percent.

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Bernanke assured lawmakers that the Fed would "provide adequate insurance" against a downturn in the form of cheaper money.

The Fed's rate cuts have led to a more modest decline in mortgage rates for borrowers with good credit, but they have done little to ease the broader credit squeeze.

Bernanke agreed that banks and other lenders have been pulling back, both because of increased aversion to risk and because they have been forced to book huge losses from soured loans and to repurchase troubled mortgages and loans they had sold to investors.

The unexpected losses and growing pressures, he continued, have prompted banks to become more restrictive in their lending and more "protective of their liquidity."

Bernanke said the economy would grow slowly but pick up speed later in response to both the Fed's lower interest rates and the $168 billion economic stimulus package that President Bush signed Wednesday.

"At present, my baseline outlook involves a period of sluggish growth, followed by a somewhat stronger pace of growth starting later this year," he told lawmakers. But in warning that his outlook could turn out to be wrong, the Fed chairman left the door open for more rate cuts.


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