Bernanke gains advantage against crisis in credit, but can he beat back a recession?

Staring down the biggest crisis of his 18-month tenure as chairman of the Federal Reserve, Ben Bernanke needed an ace.

In mid-August, credit markets seized up as investors lost almost all appetite for risk. Bernanke's response left the crowd of financial pundits in awe. By lowering the cost of borrowing from its discount window, and making it clear that the Fed would accept as collateral the troubled mortgages that triggered the credit standoff, the crisis eased.

"The Fed has been fairly ingenious in my mind," says economist Ray Stone of Stone & McCarthy Research Associates.

On Sept. 18, the Fed will decide if it should unleash the central bank's most powerful maneuver: a change in the benchmark lending rate known as the federal funds rate.

This is the rate used as the basis for loans to consumers and businesses. Investors may get a hint of the plan today when Bernanke speaks at an annual Fed conference in Wyoming.

The Fed faces pressure to act. Consumer confidence has fallen along with home prices. Shipments of manufactured goods have been paltry. Merrill Lynch economist David Rosenberg says a recession may be unavoidable. "We will see the debate shift — to whether we are going to see a mild recession or a severe one," he wrote recently to clients.

Economists say the safest move would be to cut rates to 5 percent, from 5.25 percent today. The Fed could also make a more drastic 0.5 percentage point cut, though some critics say this would amount to a bailout for hedge funds and loose lenders who got caught holding bad mortgages.

If the Fed cuts, it won't base its decision on the portfolios of investors, says Mark Gertler, a professor of economics at New York University.

A cut is not a certainty. The Fed may discount the risk of a recession, opting instead to keep the target on inflation by leaving rates unchanged. This would once again send investors fleeing riskier assets, Stone says. That's an option that big investors don't welcome. "It would be a blow," he says.