Warning that the timing of an economic recovery is “highly uncertain,” Federal Reserve Chairman Ben S. Bernanke said yesterday (Tuesday) that an economic stimulus program might not be enough to do the job. Bernanke went on to say that the government might have to buy or guarantee banks’ toxic assets to revive growth.

“The Federal Reserve will do its part to promote economic recovery, but other policy measures will be needed as well,” Bernanke said during a speech at the London School of Economics. “The incoming administration and the Congress are currently discussing a substantial fiscal package that, if enacted, could provide a significant boost to economic activity. In my view, however, fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system.”

Bernanke’s remarks indicate he may be more concerned about the continuing chokehold banks have put on credit to companies and households than he is about offering immediate aid to homeowners facing foreclosure. He may also want to influence how Congress and President-elect Barack Obama plan to spend the next $350 million of the financial bailout fund.

Bernanke “is waking up to the reality that it is worse than he thought,”Janet Tavakoli, president and founder of Tavakoli Structured Finance in Chicago told Bloomberg News. “We don’t have any investment banks that are doing just fine. The whole situation is very tenuous.”

Bernanke denied the Fed is currently using “quantitative easing,” the radical approach taken by the Japanese authorities to pull the economy out of its “lost decade” in the 1990s. Instead, the central bank is targeting specific areas of the economy where liquidity has dried up for “credit easing”, reported the Guardian.

“Credit spreads are much wider and credit markets more dysfunctional in the United States today than was the case during the Japanese experiment,”Bernanke said.

Besides lowering the Federal Funds rate to a range of zero to 0.25%, the Fed’s has launched efforts to reduce credit spreads by purchasing long-term U.S. Treasuries and mortgage-backed securities, hoping to improve the functioning of private credit markets as well.

Meanwhile, the size and types of assets on the Fed’s balance sheet grew by more than more than $1 trillion last year, more than any time in the institution’s history. But even with the government printing presses running 24/7 to add new dollars to the financial system, Bernanke sees little danger of inflation.

“Banks are choosing to leave the great bulk of their excess reserves idle, in most cases on deposit with the Fed,”Bernanke said in London. “At this point with global economic activity weak, and commodity prices at low levels… we see little risk of inflation in the near term; indeed we expect inflation to continue to moderate.”

Public purchases of bad bank assets were once originally envisioned as the way to fix the economy under U.S. Treasury Secretary Henry Paulson’s Troubled Asset Relief Program, or TARP.  But the plan was later revised to instead inject liquidity into the banks to encourage lending.

That plan backfired when the banks instead used the funds for other purposes. As an ongoing Money Morning investigation has demonstrated, billions in U.S. bank rescue funds are financing buyouts worldwide – instead of lending at home. Some of those buyout deals are being done in markets as far away as China. Meanwhile, credit remains tight here in the U.S. market, a situation that could be alleviated if only the banks made the bailout money available to consumers in the form of loans.

Bernanke’s warning about toxic assets is “a call to use the second half of TARP for what it was intended for,”said Christopher Low, chief economist at FTN Financial in New York. “It was sold as something to get the mortgage market functioning again, which is something Congress would like to see because that gets back to homeowners.”

Source: Bernanke Casts Doubt on Stimulus, Says Fed May Buy Toxic Assets to Loosen Credit