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Originally published Wednesday, July 16, 2008 at 12:00 AM

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No "magic wand" for economy

The nation's leaders are running out of answers to America's economic crisis. The Federal Reserve has no more practical room to push interest...

The Associated Press

WASHINGTON — The nation's leaders are running out of answers to America's economic crisis.

The Federal Reserve has no more practical room to push interest rates lower; there's only so much taxpayer money for shoring up housing, and if depositors lose confidence there's little officials can do to stop a run on banks.

President Bush, speaking from a White House podium, and Federal Reserve Chairman Ben Bernanke, in testimony to a congressional committee, sought Tuesday to soothe jittery markets and reassure Americans that the U.S. financial system remains basically sound despite the turmoil.

But they tempered their remarks with warnings and expressions of uncertainty.

Bernanke warned the U.S. economy faces "numerous difficulties," the outlook for inflation is unclear and "financial markets and institutions remain under considerable stress."

Bush told a news conference: "The president doesn't have a magic wand." He was answering a question about soaring fuel prices but his remarks seemed to sum up the government's overall predicament.

After years of seeming tame, inflation is on the rise, led by higher food and fuel costs. But the Fed, which usually fights inflation by boosting interest rates, is unable to use that weapon — it already has pushed rates down to 2 percent from 5.25 percent in response to the housing crisis — without threatening to undermine an economy that is either in recession or growing anemically.

With soaring budget deficits, swollen from the costs of wars in Iraq and Afghanistan and increased spending on homeland security, there's only so much taxpayer money for bailing out failing financial institutions.

Stocks are in a bear market, and shares of banks and other financial companies have been pounded.

"I fear that we're sitting on a financial powder keg," Bernanke was told by Sen. Richard Shelby of Alabama, senior Republican on the Banking Committee.

Mortgage giants Fannie Mae and Freddie Mac hold or guarantee about half the home mortgages in the United States. Their stocks have lost about 80 percent of their value during the past year.

Over the weekend, the Treasury Department and the Fed threw them a lifeline. But if investor jitters prevent them from being able to sell bonds to finance new mortgages, it could have far-reaching economic consequences.

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And the risk of runs on banks is still present, although minimized by federal deposit insurance on accounts up to $100,000 and by other federal safeguards.

Regulators seized IndyMac, a large California-based savings and loan association, on Friday after hundreds of depositors lined up to withdraw funds at branches. The bank reopened Monday under federal control.

Bush counseled calmness.

"I happened to witness a bank run in Midland, Texas, one time. I'll never forget the guy standing in the bank lobby saying, your deposits are good. We got you insured. You don't have to worry about it if you got less than $100,000 in the bank," Bush recalled.

"The problem was, people didn't hear. And there's a ... nervousness. My hope is, is that people take a deep breath and realize that their deposits are protected by our government."

But nearly $1 billion of IndyMac's approximately $19 billion in deposits was uninsured, according to the Federal Deposit Insurance Corp.

The administration unveiled a U.S. rescue plan for Fannie Mae and Freddie Mac, but it has not put a price tag on it.

Treasury Secretary Henry Paulson said the administration didn't intend to nationalize the companies and wanted to preserve their investor-owned structure. Still, he said a regulatory overhaul was needed.

Congress is also working on legislation that would modernize the Federal Housing Administration and create a new regulator and tighter controls for Fannie Mae and Freddie Mac.

If the government wound up taking over the two companies, it would have to assume more than $5 trillion in mortgage debt the two companies now either own or back. That would add to a federal debt fast approaching the $10 trillion mark.

Bernanke defended the Fed's decision to help rescue Bear Stearns as well as Fannie and Freddie. If problems aren't contained, they can ripple throughout the economy, hurting everyone, he said. "Financial stability is critical to economic stability."

David Jones, an economist at DMJ Advisors and a longtime Fed watcher, said Bernanke's testimony suggested the Fed's "emphasis has shifted to financial stability," perhaps signaling it will leave interest rates unchanged until late 2008.

Copyright © 2008 The Seattle Times Company

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