Twin Crises Feed the Spiral

By JON HILSENRATH and PHRED DVORAK

U.S. Federal Reserve Chairman Ben Bernanke held out hope for an economic recovery by 2010 -- even as new signs emerged that the recession and financial crisis are feeding on each other in ways that worsen both.

The confidence of U.S. consumers tumbled in February to its lowest level in more than 41 years, partly because people are increasingly discouraged about job prospects. Two fresh measurements suggest home-price declines are accelerating. New Fed data showed rising bank-loan delinquencies. And companies from software giant Microsoft Corp. to retailers Office Depot Inc. and Macy's Inc. reported a worsening profit outlook.

In one relative counterpoint to the gloom, stocks bounced off Monday's 11-year lows after Mr. Bernanke played down the need to nationalize American banks. The Dow Jones Industrial Average snapped three days of loses, rising 3.32%, to 7350.94. Still, it is down 48% from its October 2007 peak.

Mr. Bernanke also issued a stark warning: Economic revival hinges on policymakers' ability to break the "destructive power" of the deeply intertwined twin crises in banking and the broader economy.

In what economists are calling an "adverse feedback loop," job losses and falling corporate profits are creating new loan defaults, hurting banks beyond the original mortgage problems that started the financial crisis. The banks' falling stock prices, along with loan defaults, make it harder for them to raise capital and more reluctant to lend. All this saps the economy's lifeblood -- spending on cars, factory equipment or other goods -- feeding the cycle of job cuts and falling profits.

Financial-rescue packages and a $780 billion fiscal-stimulus plan are meant to break the U.S. economy's downward spiral. But so far it isn't working. "If actions taken by the administration, the Congress and the Federal Reserve are successful in restoring some measure of financial stability -- and only if that is the case, in my view -- there is a reasonable prospect that the current recession will end in 2009," Mr. Bernanke said in testimony to lawmakers.

Fed data released Tuesday showed that delinquency rates on consumer and business loans at large banks marched higher in the fourth quarter, led by increases in residential-mortgage delinquencies, which neared 7% of outstanding mortgages.

A report by retailer Target Corp. that net income fell 41% in the fourth quarter pointed to the self-feeding nature of the recession and financial crisis. For instance, Target's expenses from bad credit-card debt nearly tripled, mirroring similar problems at banks, which are seeing economic problems seep into new corners of their portfolios, including credit cards and commercial real estate.

"Current economic conditions have created a fundamental shift in shopping behavior, as consumers seek ways to stretch their dollars and pull back on their purchases," Kathee Tesija, a Target executive vice president, told investors in a conference call.

Microsoft's chief executive, Steve Ballmer, offered a gloomy assessment. "I think the economy will be relatively weak for a relatively long time," he said as the company reiterated that sales and profit in the second half of its fiscal year ending June would be below the year-earlier period.

Office Depot posted a $1.5 billion net loss for the fourth-quarter as sales fell 15% to $3.3 billion. "Our customers simply can't buy," Chief Executive Steve Odland said in a Tuesday conference call.

Fed officials expect the unemployment rate to reach 8.8% this year, much higher than they expected a few months ago.

The jobless rate has already risen to 7.6%, and fresh data indicate that Americans are pessimistic that the outlook will improve any time soon. The Conference Board's consumer-confidence index fell to 25 in February, its lowest level since monthly data were first collected in 1967, and 48% of people surveyed said jobs were hard to get, the largest percentage since February 1992. Some 47% said they expected jobs to decrease in the months ahead, the highest percentage since December 1973.

Almost a quarter of respondents said they expected their incomes to decrease over the next six months, an all-time high.

Even as Mr. Bernanke spoke, U.S. authorities were considering whether to rewrite financial rescues of two of the nation's largest financial institutions, insurer American International Group Inc. and banking giant Citigroup Inc.

The Fed and Treasury have already committed hundreds of billions of dollars to both firms. But just as government money was pumped into them last year, the worsening economy and financial-market turmoil deepened their losses, eating further into the firms' financial cushions. Revised rescues for both firms could deepen the federal government's control of the firms and exposure to their problems.

The housing sector -- which is at the core of the crises for both the economy and financial markets -- also showed signs of worsening.

U.S. home prices fell 3.4% on a seasonally adjusted basis during the fourth quarter of 2008, a record drop, according to a government index released Tuesday. The drop surpassed the 2% decline reported for the third quarter and was the largest decrease in the index's 18-year history, the Federal Housing Finance Agency said.

The early causes of the housing contraction -- oversupply, tightening lending -- have been compounded by falling incomes and rising joblessness. A separate set of home-price indexes, from S&P/Case-Shiller, showed that nationally, prices were down 27% from their mid-2006 peak, with particularly large losses in areas like Phoenix, Las Vegas and San Francisco.

"There are very few, if any, pockets of turnaround that one can see in the data," said David M. Blitzer, chairman of S&P's index committee.

Write to Jon Hilsenrath at jon.hilsenrath@wsj.com and Phred Dvorak at phred.dvorak@wsj.com