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Alarms sounded in US$700bn bailout push

The Fed chairman and Treasury secretary try to reassure a sceptical economic community.

The Federal Reserve chairman, Ben Bernanke, and the Treasury secretary, Henry Paulson, are not saying it will be a return to the Great Depression of the 1930s if the government does not pass a US$700 billion (Dh2.57 trillion) bailout bill. However, private economists do not all share that assessment. Mr Bernanke told members of the Senate Banking Committee on Tuesday that if Congress does not act, unemployment will rise and the overall economy will shrink, normally a sign of a recession.

"I think if this is not done, that it will be of significant adverse consequences for the average person in the United States," said Mr Bernanke, adding, "I do believe we need to act to stabilise the situation, which is continuing to be very unpredictable, very worrisome." Mr Paulson, the Bush administration's chief economic spokesman, sounded an equally dire message, saying, "We saw market turmoil reach a new level last week and spill over into the rest of the economy. We must now take further, decisive action to fundamentally and comprehensively address the root cause of this turmoil."

Both officials are apparently sending even more urgent messages in private, according to the accounts of participants who heard both men at a pivotal meeting last Thursday night in the office of House Speaker Nancy Pelosi. "Bernanke told us that our American economy's arteries - our financial system - were clogged and if we don't act, the patient would surely suffer a heart attack," Senator Charles Schumer, one of those at the meeting, said yesterday.

Private economists agree that the analogy to the circulatory system is a good one to describe the importance of credit to the financial markets. Credit is the crucial grease that keeps the economic machine humming and it has been severely compromised because of the current credit crisis, which has made banks fearful to extend new loans because of their growing mountain of bad debt. Some analysts, however, said that the administration's proposal to use $700bn of taxpayer money to buy up those bad loans from financial institutions is not necessarily a panacea for the country's current problems.

They noted that the dollar's value against foreign currencies took a nosedive as information about the plan was processed by foreign investors, who were worried that the federal budget deficit, already projected to hit an all-time high next year, will surge even more to pay for the bailout.

Analysts said that as more is known about the Mr Paulson's plan, there are also questions being raised about its complexity and whether it would actually work well enough to get credit markets unfrozen. The bottom line, these analysts said, was that if Congress does not pass the administration's proposal, the economy won't suddenly tip into a far worse situation than it faces at present, where it is already flirting with a recession.

"If we don't get the Paulson plan, there will be some pain and suffering, but I don't think it will be the end of the world," said Sung Won Sohn, an economist at California State University, Channel Islands. "We have gone through tough times before, but we have a resilient economy and we will rebound."

While the current upheaval is being called the worst shock to hit Wall Street since the 1929 stock market crash which brought on the Great Depression, Mr Sohn said that the economy is far different today than it was 80 years ago. He said the financial system is better able to withstand shocks today and policymakers have a far better understanding of what needs to be done, especially in the ability of the Federal Reserve to boost financial resources.

"This is a totally different situation than the Great Depression," Mr Sohn said. "Back then the government was the main contributor to the problem by raising taxes to balance the budget and allowing the money supply to contract by one-third."

In the current crisis, the Fed has been shovelling money out the door since the crisis first hit in August 2007 as banks began to suffer the ill effects of billions of dollars of losses on subprime mortgages. Mr Bernanke, a former Princeton professor whose academic speciality involved studying the Great Depression, has employed a number of innovative responses to avoid making the mistakes the Fed did back in the 1930s.

Other analysts said while the economy will likely muddle through, it will not perform as well without a government support program, either Mr Paulson's plan or some other approach to help relieve financial institutions of the bad debt that is keeping them from operating normally to supply credit to the economy. Members of Congress, however, worried about the reaction from voters so close to an election to passing a massive bailout for Wall Street, have let Mr Paulson know that the plan will need to be changed if the administration wants to win passage. Economists who support the plan said that lawmakers who are now discounting the dire economic warnings being sounded by Mr Bernanke and Mr Paulson might do a fast about-face if financial markets suddenly take another nosedive. It was a market meltdown in response to last week's upheavals including the collapse of investment bank Lehman Brothers, the largest bankruptcy in US history, and the government takeover of the insurance behemoth, American International Group, that spurred Mr Paulson to come up with his bailout plan. "Investors are watching events in Washington," said Mark Zandi, the chief economist at Moody's Economy.com, "and they are likely to make up their minds very quickly." * AP

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