TOP OFFICIALS SEE BLEAKER OUTLOOK FOR THE ECONOMY

BYLINE: By EDMUND L. ANDREWS
The New York Times

February 15, 2008 Friday
Late Edition - Final

SECTION: Section A; Column 0; Business/Financial Desk; Pg. 1

With the credit markets once again deteriorating, the nation's two top economic policy makers acknowledged Thursday that the outlook for the economy had worsened, as both came under criticism for being overtaken by events and failing to act boldly enough.

In testimony to Congress, Ben S. Bernanke, the chairman of the Federal Reserve, signaled that the Fed was ready to reduce interest rates yet again, pointing out that problems in housing and mortgage-related markets had spread more widely and proved more intractable than he predicted three months ago.

His sobering assessment was echoed by Treasury Secretary Henry M. Paulson Jr., who appeared with him. Both continued to avoid predicting a recession but said they were scaling back the more optimistic forecasts they had issued in November.

Ethan S. Harris, chief United States economist for Lehman Brothers, said that both policy makers had ''come clean'' about the economy's problems but that investors were not impressed.

Stock prices, which normally rally when the Fed hints it will lower borrowing costs, tumbled instead. The Dow Jones industrial average dropped 175 points, or 1.4 percent; broader stock indexes dropped by similar amounts.

Anxiety is escalating among institutional lenders and major borrowers, as the panic over soaring default rates on subprime mortgages that began last summer continues to spread, freezing up credit for municipalities, hospitals, student loans and even investment funds holding the most conservative bonds.

On Capitol Hill, the economic policy makers found themselves in the line of fire. Senator Robert Menendez, Democrat of New Jersey, accused both Mr. Bernanke and Mr. Paulson of having ''hit the snooze button.''

Senator Christopher J. Dodd of Connecticut, chairman of the Banking Committee, told reporters after the hearing that ''it just seems as if they aren't as concerned about the magnitude of the problem.''

Testifying before the committee, Mr. Bernanke said he still expected the economy to grow at a ''sluggish'' pace over the next few months and to pick up speed later in the year. But he said ''the downside risks to growth have increased,'' noting that spiraling losses in home mortgages have dragged down the credit markets and shaken the broader economy.

While trying to be optimistic, Mr. Paulson said that the administration's forecast ''would be less, but I do believe we'll keep growing.''

Many Wall Street economic forecasters, however, are already estimating that the risks of a recession are at least 50-50, and a growing number of analysts contend that an economic contraction may have already begun.

Fed policy makers will release their newest forecasts on Wednesday, and Mr. Bernanke said they would be more in line with those of private-sector economists.

The Fed has reduced its benchmark interest rate, called the federal funds rate, five times since September, including two cuts within eight days last month. The rate has fallen to 3 percent; as recently as late summer of last year it was 5.25 percent.

Mr. Bernanke assured lawmakers that the Fed would ''provide adequate insurance'' against a downturn in the form of cheaper money.

But neither investors nor politicians have responded particularly favorably to Washington's moves. Yields on asset-backed securities that hold mortgages and other debt have risen to levels almost as high as they were last August, when financial markets first seized up in response to soaring default rates on subprime mortgages.

The Fed's rate cuts have led to a more modest decline in mortgage rates for borrowers with good credit, but they have done little to ease the broader credit squeeze.

Mr. Bernanke agreed that banks and other lenders have been pulling back, both because of increased aversion to risk and because they have been forced to book huge losses from soured loans and to repurchase troubled mortgages and loans they had sold to investors.

The unexpected losses and growing pressures, he continued, have prompted banks to become more restrictive in their lending and more ''protective of their liquidity.''

Mr. Bernanke said the economy would grow slowly but pick up speed later in response to both the Fed's lower interest rates and the $168 billion economic stimulus package that President Bush signed Wednesday.

''At present, my baseline outlook involves a period of sluggish growth, followed by a somewhat stronger pace of growth starting later this year,'' he told lawmakers. But in cautioning that his outlook could turn out to be wrong, the Fed chairman left the door open to additional rate reductions.

Mr. Paulson tried to sound less downbeat. ''I believe we are going to continue to grow, albeit at a slower rate,'' he told the Banking Committee, insisting that the plunge in housing and credit markets was a correction rather than a crisis.

Mr. Bernanke said a wide variety of economic indicators had declined in recent months, as the meltdown in the housing and mortgage markets rippled through the broader economy.

The Fed chairman said the job market had worsened, noting employment fell by 17,000 jobs in January, according to the Labor Department. That was down from an average rise of 95,000 jobs a month in the final three months of 2007. Unemployment, though still comparatively low, at 4.9 percent, has edged up from 4.7 percent a few months ago.

Nationwide, housing prices have declined and show no signs of having hit bottom, while the stock markets have fallen sharply from their highs late last year.

Mr. Dodd has proposed legislation to create an agency to bail out many homeowners by buying up and restructuring troubled mortgages. He painted a particularly bleak picture.

''The current economic situation is more than merely a 'slowdown' or a 'downturn,' '' he said. ''It is a crisis of confidence among consumers and investors.''

Mr. Paulson and other administration officials staunchly oppose a government buyout program, arguing that the tax rebates and business tax cuts in the new stimulus package should keep the nation out of a recession.

But Senator Richard C. Shelby of Alabama, ranking Republican on the Banking Committee, predicted the bill's tax rebates and temporary tax cuts for business would have a negligible impact.

''I have equated it to pouring a glass of water in the ocean and expecting it to make a difference,'' Mr. Shelby said.

Though lawmakers welcomed the Fed's willingness to lower interest rates, investors had already been assuming that events would force the Fed's hand.

Prices in the federal funds futures market, which allows investors to bet on the coming course of rates, indicate investors expect the central bank to reduce its benchmark overnight rate another full percentage point, to 2 percent, by the end of June.