World and Nation

Stimulus Also Requires Stability, Bernanke Says

The chairman of the Federal Reserve, Ben S. Bernanke, warned Tuesday that the highly unpopular job of using taxpayer money to bail out financial institutions in the United States and other countries was far from over.

One day after President Bush, at the request of President-elect Barack Obama, asked Congress to free up the second half of the money for the Treasury Department’s $700 billion financial rescue program, Bernanke cautioned that banks and other lending institutions were still not functioning properly and would probably need additional money.

“More capital injections and guarantees may become necessary to ensure stability and the normalization of credit markets,” Bernanke said during a speech at the London School of Economics.

Though the Fed chairman acknowledged that people in many countries were “understandably concerned” about pumping government money into the financial industry while often turning a cold shoulder to other sectors, he defended the effort as unpleasant but necessary.

“This disparate treatment, unappealing as it is, appears unavoidable,” he said. “Our economic system is critically dependent on the free flow of credit, and the consequences for the broader economy of financial instability are thus powerful and quickly felt.”

Indeed, Bernanke suggested that Obama might want to revive the original idea of the rescue plan to buy unsellable mortgage-backed securities and other illiquid assets. That idea was originally the centerpiece of the program as it was first promoted by the current Treasury secretary, Henry M. Paulson Jr. Paulson abandoned the idea before getting started, arguing that it would be faster and more efficient to inject capital directly into the biggest banks and investment firms.

In a separate appearance on Tuesday in Washington, the Fed’s vice chairman, Donald L. Kohn, said that financial institutions were still “clogged” by hard-to-sell assets and still needed help.

Bernanke supported the efforts by Congress and Obama to put together a fiscal stimulus program worth roughly $800 billion over two years that would be weighted heavily toward big new spending on infrastructure projects, like bridges and schools, “green” energy projects and expanded safety-net programs like unemployment benefits. Both Kohn and Bernanke seemed to be warning lawmakers that they could not focus exclusively on comparatively popular spending and tax-cut programs.

A stimulus package relying on extensive borrowing “could provide a significant boost to economic activity,” Bernanke said. But “fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system.”

Beyond buying troubled assets from banks, Bernanke said, another option is to provide asset guarantees under which the government would absorb part of the banks’ losses in exchange for warrants or other forms of compensation.