Published: October 15, 2008 01:05 pm      

Bush, Paulson say economy's rebound will take time

WASHINGTON (AP) - The economy shot warning flares on Wednesday that it was still in profound trouble despite the government's latest financial rescue plan.

Wall Street noticed and shares sank on worries the U.S. was in a recession or would soon be in one. The market for lending between banks — a key gauge of the plan's effectiveness — remained tight, although there were some signs of improvement.

President Bush, Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke sought to reassure anxious Americans that relief will come, but it will take time and patience for the plan's unprecedented steps to stabilize the system, induce banks to lend again, and — in time — help improve the economy.

Bush, in a meeting with his Cabinet, said he's confident that "in the long run, that this economy will come back."

Even as he spoke, the economy was showing the kind of hurdles it has to leap. Retail sales slumped in September and wholesale prices remained high.

"This will take time. There will be challenges," Paulson said on ABC's "Good Morning America." He acknowledged that he initially opposed this type of government intervention into the banking industry but that new facts changed the circumstances in recent days.

Paulson said, "There's no doubt that the way to get the maximum bang for the taxpayers here was to invest in banks."

Bernanke also called for patience. He said the economy was currently battling a severe credit crunch, slowdowns in consumer spending and business investment and rising unemployment.

"Stabilization of the financial markets is a critical first step, but even if they stabilize as we hope they will, broader economic recovery will not happen right away," Bernanke said in a speech to the Economic Club of New York.

The Fed chairman, who has worked closely with Paulson in the current crisis, said the government's new powers under the $700 billion financial bailout package passed by Congress on Oct. 3 should help reduce risks and restore confidence.

"We now have the tools we need to respond with the necessary force to these challenges," Bernanke said.

But investors on Wall Street and around the world weren't able to cast off their worries about the economy — despite the rescue plan. The Dow Jones industrials sank 400 points in late morning trading after JPMorgan Chase & Co. reported a whopping 84 percent drop in its third-quarter profit.

Broader stock indicators also declined. The Standard & Poor's 500 index fell 4.6 percent and the Nasdaq composite index fell 3.6 percent.

Beyond stocks, the credit markets have been showing tentative signs of recovery, though they remain strained, and demand for safe assets remains high. The three-month Treasury bill's yield slipped on Wednesday. Low yields show that investors are willing to earn meager returns as long as their investment is preserved.

Key lending rates between banks in the U.S. and Europe inched down, after major central banks offered the banking sector unlimited amounts of short-term loans in dollars. This was meant to keep credit markets flowing while lenders regain confidence in the interbank lending system and came on top of government rescue packages. Across different national plans, European governments and the United States have over the past several weeks committed some $3 trillion to bank guarantees, equity injections and other assistance.

Sales at U.S. retailers fell with a thud in September, dropping by 1.2 percent, the most in three years. Uncertainty about the economy — and their own financial fortunes — probably will force consumers and businesses alike to hunker down further, spelling more problems for the already troubled economy.

Another report showed that wholesale prices dropped for the second straight month, as energy costs retreated from record highs. Yet many other prices are up sharply over the past year and are squeezing businesses. When energy and food prices are stripped out, all other wholesale prices tracked racked up their biggest annual increase in more than 17 years.

Anxiety about the economy is the No. 1 concern of voters. With the presidential election just weeks away, Democrat Barack Obama and Republican rival John McCain are working furiously to convince people that each is the best choice to steer the economy through these perilous times.

Many economists believe the country is on the edge of — or already in — its first recession since 2001.

If the government's new plan works — it will merely cushion the blow. Democrats on Capitol Hill are pushing for another round of stimulus that could cost as much as $150 billion, an effort to provide additional relief and lift the country out of the doldrums.

Asked about a push in Congress for a new stimulus package to help the economy, he said on CBS's "The Early Show" that he is focused for now on "restoring confidence in the financial system, and that will do more for the economy than any single thing. You get banks lending going again, supporting businesses, supporting jobs, supporting consumers, that's what we need to do."

Big U.S. banks started falling in line Tuesday behind the rejiggered bailout plan.

The first bank to take advantage of the program was Bank of New York Mellon which announced it would sell $3 billion in preferred shares to the Treasury. Other banks initially participating include Goldman Sachs Group Inc., Morgan Stanley, JPMorgan Chase, Bank of America Corp., including the soon-to-acquired Merrill Lynch, Citigroup Inc., Wells Fargo & Co., and State Street Corp.

But there was a mix of hope and skepticism on whether the plan would work. Unprecedented steps recently taken — including hefty interest rate reductions by the Fed and other major central banks in a coordinated assault just last week — have failed to break through the credit clog and the panicky mind-set gripping investors on Wall Street and around the globe.

Initially the U.S. government will pour $125 billion into nine major banks with the hope that they will use the money to rebuild their reserves and to increase lending to consumers and businesses. Another $125 billion will be made available this year to other banks — if they need it — for cash infusions.

In return, the government will get ownership stakes in the financial institutions. Banks, meanwhile, will have to accept limitations on executives' compensation.

The government is counting on banks not to just clutch onto the cash, which aggravated the credit crisis to begin with.

"The needs of our economy require that our financial institutions not take this new capital to hoard it, but to deploy it," Paulson said in announcing the initiative.

Treasury switched gears, deciding to first use a chunk of the $700 billion from the recently enacted financial bailout package to pay for taking partial ownership stakes in banks, rather than using the money to buy rotten debts from financial institutions. The government said it still intends to buy the bad mortgages and other toxic assets, another move aimed at getting credit flowing again.

Besides the $250 billion this year on the stock purchases, Bush said Tuesday that an additional $100 billion would be needed in connection with covering bad assets. That would leave $350 billion of the $700 billion program, presumably to be spent by the next president.

Economists as well as both Democratic and Republican lawmakers on Capitol Hill had urged Treasury to first move forward on the capital injection plan, arguing that was a more effective way to battle the financial crisis.

The government's cash infusions are attractive to banks because they are having trouble getting money from elsewhere. Skittish investors have cut them off, moving their money into safer Treasury securities. Financial institutions are hoarding whatever cash they have rather than lending it to each other or customers.