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Bernanke: Fed Can Handle Expanded Role For Economy

Federal Reserve Chairman Ben Bernanke on Tuesday fended off congressional skepticism about expanding the Fed's duties to police big financial companies given the central bank's failure to catch problems that led to the financial crisis.

Federal Reserve Chairman Ben Bernanke
J. Scott Applewhite
Federal Reserve Chairman Ben Bernanke

Bernanke also faced some grilling from the House Financial Services Committee about taxpayer bailouts of financial companies, slow moving efforts to curb home foreclosures and concerns about the Fed's track record in protecting consumers from abusive practices from lenders, credit card companies and other financial service providers.

"The Fed has made some big mistakes," said the panel's highest-ranking Republican, Spencer Bachus of Alabama. Letting the Fed become the financial supercop would be "just inviting a false sense of security" that would be shattered at taxpayers' expense, he warned.

Bernanke argued that the Obama administration's proposal would be a "modest reorientation" of the Fed's powers, not a great expansion of them.

The Fed chief also sought to beat back an administration proposal that would create a new consumer protection regulator for financial services and strip some of those duties from the central bank.

Consumer groups and lawmakers have blamed the Fed for not cracking down early on dubious mortgages practices that fed the housing boom and figured into its collapse. Later this week, the Fed will issue a proposal boosting disclosures on mortgages and home equity lines of credit. It also will include new rules governing the compensation of mortgage originators.

The Fed chief urged Congress to keep proposals to audit the Fed away from monetary policy duties. "A perceived loss of monetary policy independence could raise fears about future inflation," he warned.

Ron Paul, R-Texas, a frequent Fed critic, rejected that argument and said the Fed already makes political calculations. "Just the fact that (the Fed) can issue a lot of loans and special privileges to banks and corporations," Paul said. "That's political."

Bill Posey, R-Fla., who wants the Fed to be more open, argued that some people rightly say "you can find out more about the operations of the CIA, than the Fed. The public has the right to know."

Bernanke's term expires early next year, and President Barack Obama will have to decide whether to reappoint him. The Fed chief's innovative policies have been credited with pulling the economy from the edge of the abyss last year. But those actions also have touched off criticism about putting taxpayers at risk and whether the government should be cleaning up Wall Street messes.

The Fed boss sought to assure investors and Congress that the Fed will be able to reel in its extraordinary economic stimulus and prevent a flare up of inflation when the recovery is more firmly rooted. Any such steps will be far off in the future and the central bank's focus remains "fostering economic recovery," he said.

To that end, Bernanke again pledged to keep its key bank lending rate at a record low near zero for an "extended period." Economists predict rates will stay at record lows through the rest of this year.

Laying out a plan now to unwind the Fed's stimulus may give Bernanke more leeway to hold rates at record lows to brace the economy. That's because doing so could tamp down investors' fears that the Fed's aggressive actions to lift the country out of its longest recession since World War II could spur inflation later on.

"It is important to assure the public and the markets that the extraordinary policy measures we have taken in response to the financial crisis and the recession can be withdrawn in a smooth and timely manner as needed, thereby avoiding the risk that policy stimulus could lead to a future rise in inflation," Bernanke said. "We are confident that we have the necessary tools to implement that strategy when appropriate."

To revive the economy, the Fed has plowed trillions into the financial system in an effort to drive down rates on mortgages and other consumer debt. It also has created programs to bust through credit clogs, a key ingredient to turning the economy around.

When the time comes, the Fed will need to soak up that money. Besides raising its key bank lending rate, the Fed can raise the rate it pays banks on reserve balances held at the central bank, Bernanke said. That would give banks an incentive to keep their money parked there, rather having it flow back into the financial system, where it can stoke inflationary pressures.

The Fed also can drain money from the financial system by selling securities from its portfolio with an agreement to buy them back at a later date or it can sell securities outright.

Steering the economy from recession to recovery will be a delicate move for Bernanke -- economically and politically.

On the economic front, Bernanke repeated the Fed's forecast that the economy should start growing again in the second half of this year, but he warned growth would be slight, leading to higher unemployment.

Despite some improvements -- including a stabilization in consumer spending and moderating declines in housing activity -- the economy remains vulnerable, he said.

"Job insecurity, together with declines in home values and tight credit, is likely to limit gains in consumer spending," Bernanke said. "The possibility that the recent stabilization in household spending will prove transient is an important downside risk to the outlook."

The nation's unemployment rate climbed to a 26-year high of 9.5 percent in June. The Fed says it could rise as high as 10.1 percent this year, and stay elevated into 2011. The post-World War II high was 10.8 percent at the end of 1982, when the country had suffered through a severe recession.

Expectations for a lethargic recovery should keep a lid on inflation this year, Bernanke said. With consumers likely to stay cautious amid rising unemployment, companies won't be able to jack up prices.

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