WASHINGTON (MNI) – The following is an excerpt from Federal Reserve
Chairman Ben Bernanke’s semi-annual testimony prepared Tuesday for the
Senate Banking Committee:

Tensions in euro-area financial markets intensified again more
recently, reflecting political uncertainties in Greece and news of
losses at Spanish banks, which in turn raised questions about Spain’s
fiscal position and the resilience of the euro-area banking system more
broadly. Euro-area authorities have responded by announcing a number of
measures, including funding for the recapitalization of Spain’s troubled
banks, greater flexibility in the use of the European financial
backstops (including, potentially the flexibility to recapitalize banks
directly rather than through loans to sovereigns), and movement toward
unified supervision of euro-area banks. Even with these announcements,
however, Europe’s financial markets and economy remain under significant
stress, with spillover effects on financial and economic conditions in
the rest of the world, including the United States. Moreover, the
possibility that the situation in Europe will worsen further remains a
significant risk to the outlook.

The Federal Reserve remains in close communication with our
European counterparts. Although the politics are complex, we believe
that the European authorities have both strong incentives and sufficient
resources to resolve the crisis. At the same time, we have been focusing
on improving the resilience of our financial system to severe shocks,
including those that might emanate from Europe. The capital and
liquidity positions of U.S. banking institutions have improved
substantially in recent years, and we have been working with U.S.
financial firms to ensure they are taking steps to manage the risks
associated with the exposures in Europe. That said, European
developments that resulted in a significant disrukption in global
financial markets would inevitably pose significant challenges for our
financial system and our economy.

The second important risk to our recovery, as I mentioned, is the
domestic fiscal situation. As is well known, U.S. fiscal policies are on
an unsustainable path, and the development of a credible medium-term
plan for controlling deficits should be a high priority. At the same
time, fiscal decisions should take into account the fragility of the
recovery. That recovery could be endangered by the confluence of tax
increases and spending reductions that will take effect early next year
if no legislative action is taken. The Congressional Budget Office has
estimated that, if the full range of tax increases and spending cuts
were allowed to take effect — a scenario widely referred to as the
fiscal cliff — a shallow recession would occur early next year and
about 1 and 1/4 million fewer jobs would be created in 2012. These
estimates do not incorporate the additional negative effects likely to
result from public uncertainty about how these matters will be resolved.

** MNI Washington Bureau: 202-371-2121 **

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