Bernanke warns lawmakers to approve bailout or risk recession

WASHINGTON -- Federal Reserve chairman Ben Bernanke bluntly warned reluctant lawmakers Tuesday they risk a recession with higher unemployment and increased home foreclosures unless they act on the Bush administration's $700 billion plan to bail out the financial industry.

Despite the warning, influential lawmakers in both parties demanded changes in the White House-backed proposal, and conservative Republicans recoiled at the prospect of federal intervention into private capital markets.

Six weeks before the elections, both major party presidential contenders also insisted on alterations in the administration's prescription for the worst financial crisis in decades.

Bernanke's remarks about the risk of recession came in response to a question from Sen. Chris Dodd, D-Conn., who seemed eager to hear a strong rationale for lawmakers to act swiftly on the administration's unprecedented request.

"The financial markets are in quite fragile condition and I think absent a plan they will get worse," Bernanke said.

Ominously, he added, "I believe if the credit markets are not functioning, that jobs will be lost, that our credit rate will rise, more houses will be foreclosed upon, GDP will contract, that the economy will just not be able to recover in a normal, healthy way."

GDP is a measure of growth, and a decline correlates with a recession.

Dodd later spoke disparagingly of the administration's proposal. "What they have sent us is not acceptable," he told reporters after presiding over a lengthy Senate Banking Committee hearing at which Bernanke and Treasury Secretary Henry Paulson urged swift action by Congress.

Sen. Richard Shelby of Alabama, the panel's senior Republican, added, "We have got to look at some alternatives" to the administration's plan.

The legislation that the administration is seeking would allow the government to buy bad mortgages and other troubled assets held by endangered banks and financial institutions.

Getting those debts off their books should bolster the institutions' balance sheets, making them more inclined to lend and easing one of the biggest choke points in the credit crisis. If the plan works, it could help lift a major weight off the sputtering national economy.

The White House and key lawmakers have been in negotiations since the weekend on terms of the legislation. It was not clear what impact the new congressional complaints would have on the discussions.

"Nobody is happy" about the bailout request, said House Majority Leader Steny Hoyer, D-Md., although he spoke of possible passage of legislation by the weekend.

"Nobody wants to have to do this," agreed Rep. John Boehner of Ohio, the Republican leader. He said he was hopeful of a quick agreement.

Presidential politics have become part of the debate.

Sen. Barack Obama, the Democratic presidential candidate, called a news conference to urge changes in what he called the administration's "stubborn inflexibility."

He said Wall Street executives must not be allowed to walk away from the mess with multimillion-dollar severance packages, taxpayers who are bearing the risk of the bailout must benefit if it succeeds and homeowners should be able to get relief from unaffordable mortgages.

Obama's Republican opponent, Sen. John McCain, has also said he wants steps to limit the compensation of CEOs who leave financially wrecked firms.

The stakes were unmistakable.

"I understand speed is important, but I'm far more interested in whether or not we get this right," Dodd said at the hearing.

Later, he told reporters he hopes for legislation soon.

"But it is not going to be a blank check or a simple signing on to a bill that sends a blank check to this secretary or any other secretary." He noted that either Obama or McCain would probably be appointing a new treasury secretary after he takes over in the White House.

Across the Capitol complex, Vice President Dick Cheney and Jim Nussle, the administration's budget director, met privately with restive House Republicans, some of whom emerged from the session unpersuaded.

"Just because God created the world in seven days doesn't mean we have to pass this bill in seven days," said Rep. Joe Barton, R-Texas.

Added Rep. Darrell Issa, R-Calif., "I am emphatically against it."

Still, prospects for legislation seemed strong, with lawmakers eager to adjourn this week or next for the elections.

Differences include a demand from many Democrats and some Republicans to strip executives at failing financial firms of lucrative "golden parachutes" on their way out the door.

The administration balked at another key Democratic demand: allowing judges to rewrite bankrupt homeowners' mortgages so they could avoid foreclosure.

Paulson, seated next to Bernanke at the committee hearing, objected strongly when Sen. Chuck Schumer, D-N.Y., asked if $150 billion might be enough to get the program started, with a promise of more to come.

Paulson said that would be a "grave mistake," and would fail to give the markets the confidence they need to rebound.

Paulson repeatedly fielded questions from committee members asking why taxpayers should accept the burdens of a bailout.

"You worry about taxpayers being on the hook?" he replied at one point. "Guess what -- they're already on the hook." Paulson suggested that the fallout from the credit crisis would hit everyone's pocketbook unless forceful action was taken. Moreover, a flawed and outdated regulatory system, which didn't catch abuses, needed to be overhauled, he said.

Despite the unresolved issues, President Bush predicted the Democratic-controlled Congress would soon pass a "a robust plan to deal with serious problems." He spoke before the United Nations General Assembly.

In his testimony before the Banking Committee, Paulson told senators that quick passage of the administration's plan is "the single most effective thing we can do to help homeowners, the American people and stimulate our economy."

But even before Paulson could speak, lawmakers expressed unhappiness, criticism of the plan and -- in the case of some conservative Republicans -- outright opposition.

"This massive bailout is not a solution. It is financial socialism and it's un-American," said Sen. Jim Bunning, R-Ky.

So far this year, a dozen federally insured banks and thrifts have failed, compared with three last year. The country's largest thrift, Washington Mutual Inc., is faltering.

The U.S. has taken extraordinary measures in recent weeks to prevent a financial calamity, which would have devastating implications for the broader economy. It has, among other things, taken control of mortgage giants Fannie Mae and Freddie Mac, provided an $85 billion emergency loan to insurance colossus American International Group Inc. and temporarily banned short selling of hundreds of financial stocks.