Squeezed economy a global concern

WASHINGTON — Fresh worries spread through world markets Tuesday as a crisis of confidence battered more U.S. financial institutions and the chairman of the Federal Reserve issued a sobering assessment of economic woes.

It appeared to mark a new phase in the U.S. financial crisis, with fears of a contagion effect weighing more heavily on the global economy.

With world markets interconnected as never before — financial problems at U.S. banks are affecting pension funds in Japan, as well as depositors in California — a mounting sense that the crisis is still far from hitting bottom is adding to global troubles, including rising inflation and energy prices.

In Paris and London, stock markets fell Tuesday to their lowest levels since 2005, partly as investors doubted U.S. plans to prop up the ailing government-sponsored mortgage giants Fannie Mae and Freddie Mac. In Tokyo, the benchmark stock index fell 2 percent, slipping to levels not seen in 3-½ months, and the dollar fell to a new low against the euro.

Gloom continued to grip Washington as President Bush urged Americans not to lose faith, and the administration's latest effort to help the housing sector faced tough questioning in Congress, especially among some Republicans concerned about taxpayer liability with the rescue package, which would allow the Bush administration to lend Fannie and Freddie money and buy their stock.

A day after reports of losses by regional banks, causing some depositors to pull their money out, Bush held an unscheduled news conference at which he reminded Americans that their deposits are insured up to $100,000.

"My hope is that people take a deep breath and realize that their deposits are protected by our government," the president said. The nation's troubled financial system is "basically sound," he added.

Yet the tipping points of economic crises, analysts said, are almost always more about psychology than fundamentals, with panic over a bank's insolvency, for instance, potentially becoming a self-fulfilling prophecy.

"I think the problem now is a general confidence crisis that is complicated by some global contagion that's now spreading," said Brian Bethune, a chief economist with Global Insight of Lexington, Mass.

U.S regulators "need to act promptly and forcefully to break the psychology," he said. "The details [about Fannie and Freddie] are still vague, and there is no room for that now."

Ben Bernanke, the Federal Reserve chairman, avoided the word "recession" in testimony before the Senate Banking Committee, but he painted a picture of a U.S. economy being squeezed from all directions.

Less than a month ago, the Fed had indicated that rising inflation was starting to become a bigger concern than the slumping economy. Since then, the stock market has fallen sharply and broader problems have emerged in financial markets, and there have been new signs of slowing global growth. That led Bernanke to emphasize the risks of high inflation and a weak economy in equal measure.

The Fed chief spent the early morning testifying alone and then joined Treasury Secretary Henry Paulson Jr. and Christopher Cox, chairman of the Securities and Exchange Commission.

Bernanke offered no timetable for improved economic performance, declaring that while the risks to the overall economy were still "skewed to the downside," inflation "seems likely to move temporarily higher in the near term."

Global concern is mounting for several reasons. First, foreign institutions are heavily exposed to U.S. lending giants, and about half of U.S. mortgage-backed securities are held by foreign investors.

"The rest of the world has accumulated U.S. assets, and if these prices go down, the rest of the world suffers," said Alex Patelis, head of international economics for Merrill Lynch in London.