LONDON (AP) — A mammoth stimulus package being crafted by President-elect Barack Obama could give the economy a much-needed lift, but other steps must be taken to bolster the wobbly financial system and for any recovery to stick, Federal Reserve Chairman Ben Bernanke said Tuesday.

Specifically, Bernanke suggested the government inject more money into banks. He also offered options to deal with rotten mortgages and other bad assets held by financial institutions, a problem that has contributed to a lockup in lending. Bernanke also again called for the government to do more to curb home foreclosures.

The Fed chief’s extensive remarks, in a speech at the London School of Economics, come at a critical time as the U.S. gets ready to change its political and economic guard from President George W. Bush to Obama next week.

Bernanke said the roughly $800 billion recovery plan — a blend of tax cuts and increased government spending — now being worked on by Obama and the Democrat-controlled Congress could provide a “significant boost” to the crippled economy. But he made clear that such a plan must be part of a broader, multi-pronged government response to fight the worst financial crisis the hit the U.S. and the global economy since the 1930s.

“Fiscal policy can stimulate economic activity, but a sustained recovery will also require a comprehensive plan to stabilize the financial system and restore normal flows of credit,” Bernanke said. “History demonstrates conclusively that a modern economy cannot grow if its financial system is not operating effectively.”

To help on that front, the Fed is lending billions to financial companies and buying mounds of companies’ debt to help bust through the debilitating credit clog. And the Treasury Department is overseeing a $700 financial bailout program that has pledged to inject $250 billion into banks in return for partial government ownership. Some government money also is being used to guarantee against possible losses from risky assets held by Citigroup Inc.

Bernanke said “more capital injections and guarantees may become necessary” to stabilize financial markets and spur more lending. If Obama’s incoming Treasury secretary Timothy Geithner decides to remove toxic assets from financial institutions’ balance sheets — the original but abandoned strategy under the $700 billion bailout — Bernanke suggested some options to do that.

Public purchases of the troubled assets are one way to go, he said. Another option is to provide asset guarantees under which the government would agree to absorb — presumably in exchange for warrants or some other form of compensation — part of the prospective losses on specified portfolios of rotten assets held by banks. Yet another approach would be to set up and capitalize so-called “bad banks,” which would buy assets from the financial institutions in exchange for cash and equity in the bad bank.

One of the most pressing decisions that Geithner will face is exactly how to spend the second, $350 billion installment of the bailout fund and whether to resurrect the strategy — shelved by Bush’s Treasury secretary Henry Paulson — of buying toxic assets held by banks.

Obama’s transition team had no immediate comment Tuesday, but a letter from his incoming economic adviser Lawrence Summers to congressional leaders on Monday also called for a comprehensive approach — beyond the stimulus package — to deal with the crisis.

Some Americans and some on Capitol Hill have been upset about Treasury’s management of the $700 billion program, which has provided aid to financial companies and others on Wall Street — some of whom are blamed for getting the country into economic the mess in the first place — while other struggling industries get little or no assistance.

Bernanke said he understands this concern, but added: “This disparate treatment, unappealing as it is, appears unavoidable.”

The United States’ economic system is critically dependent on the free-flow of credit, Bernanke said. It is like the economy’s oxygen. As it has been cut off, the economy has sunk deeper into recession, taking Americans’ jobs with it.

Washington policymakers, Bernanke said, “must therefore do what they can to communicate to their constituencies why financial stabilization is essential for economic recovery and is therefore in the broader public interest.”

Obama’s political skills will be put to a high-stakes test with Congress as he seeks assess to the second half of the $700 billion bailout pot. Congress has a 15-day deadline to reject the request, which Bush made on Obama’s behalf on Monday.

Additional efforts to stem skyrocketing home foreclosures could strengthen the collapsed housing market, which in turn would buttress financial stability, Bernanke said. Obama also wants to see more done to curb foreclosures.

To cushion fallout from the recession, the Fed in December slashed its key rate to an all-time low of between zero and 0.25 percent. The Fed signaled that it would keep rates at that level for some time and pledged to use unconventional tools to revive the economy. One such tool Bernanke again mentioned is the possibility of the Fed buying longer-term Treasury securities.

The central bank will meet later this month to assess economic and financial conditions.

Even as the U.S. battles the current crisis, it must move to prevent future ones. To be effective, international cooperation is needed, Bernanke said.

“A clear lesson of the recent period is that the world is too interconnected for nations to go it alone in their economic, financial and regulatory policies,” Bernanke said. “International cooperation is thus essential if we are to address the crisis successfully and provide the basis for a healthy, sustained recovery.”

In time, the global economy will recover from the current crisis, “but the timing and strength of the recovery are highly uncertain,” he added.

Bernanke, who earlier Tuesday met with British Prime Minister Gordon Brown and Bank of England Governor Mervyn King, said he expects to see “continued weakness” in the U.S. jobs market in the first quarter of this year. The unemployment rate bolted to a 16-year high of 7.2 percent in December. For all of last year, 2.6 million jobs disappeared, the most since World War II.

“We are certainly in a very bad stage of contraction as far as employment is concerned,” he said.

However, he was hopeful of seeing some stabilization in the U.S. economy later in 2009, depending on factors like improvements in the credit market. “It isn’t rapid growth, but a stabilization and a stop to the bleeding in some sense,” he said.

Aversa reported from Washington, D.C

source: yahoo finance.

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