(AFP) – Sep 24, 2008

WASHINGTON (AFP) — Federal Reserve chairman Ben Bernanke said Wednesday the US economic outlook may be "quite adverse" without a stabilization soon in troubled financial markets.

Appearing before the Joint Economic Committee of Congress, Bernanke urged lawmakers "to act quickly to address the grave threats to financial stability that we currently face."

Bernanke said he expects the economy "to expand at a pace appreciably below its potential rate in the second half of this year and then to gradually pick up" because of ongoing troubles in housing and a global credit squeeze.

But that outlook, he said in the text of his remarks, is based on a "return to more normal functioning" of the financial system to allow credit to flow, and some improvement in the housing sector.

"The US economy continues to confront substantial challenges, including a weakening labor market and elevated inflation," he said.

"Notably, stresses in financial markets have been high and have recently intensified significantly. If financial conditions fail to improve for a protracted period, the implications for the broader economy could be quite adverse."

The comments came amid intense turmoil in financial markets with the global banking system nearly frozen because of the mountain of bad debts from troubled US real estate speculation.

Bernanke made a fresh plea to lawmakers for urgent action on a 700-billion-dollar rescue package for the financial sector -- a proposal that has been facing stiff opposition from a number of lawmakers from both parties.

"Action by the Congress is urgently required to stabilize the situation and avert what otherwise could be very serious consequences for our financial markets and for our economy," he said.

The plan to purchase soured mortgage assets that have frozen the financial system, he said, "will create liquidity and promote price discovery in the markets for these assets, while reducing investor uncertainty about the current value and prospects of financial institutions."

The latest official data showed the US economy expanded at a healthy 3.3 percent annual pace in the second quarter, although analysts say the figure was skewed by a jump in exports and one-time tax rebates from an economic stimulus package. Most forecasters expect a much weaker picture if not a recession in the second half of the year.

Bernanke did not mention recession in his remarks, but said the economy is unlikely to improve without a normalization in the banking sector, to get credit flowing.

"Given the extraordinary circumstances, greater-than-normal uncertainty surrounds any forecast of the pace of activity," he said.

"In particular, the intensification of financial stress in recent weeks, which will make lenders still more cautious about extending credit to households and business, could prove a significant further drag on growth. The downside risks to the outlook thus remain a significant concern."

Bernanke also defended the Fed decision on an 85-billion-dollar line of credit to bail out insurance giant American International Group, giving the government a stake of 79.9 percent in exchange.

"A disorderly failure of AIG would have severely threatened global financial stability and, consequently, the performance of the US economy," he said.

To ease concerns that this would reward excessive risk-taking, Bernanke said the loan "imposed significant costs and constraints on the firm's owners, managers, and creditors."

He said that the failure of investment bank Lehman Brothers, which did not get government aid, did not pose the same risks.

"The troubles at Lehman had been well known for some time," Bernanke said.

"Thus, we judged that investors and counterparties had had time to take precautionary measures."

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