Bernanke: economy faces 'numerous difficulties'

Sen. Christopher J. Dodd, D-Conn., the Banking Committee chairman, called the plan "unprecedented."

Dodd said the rescue raises serious questions "about the nature of the economic crisis facing our nation, about the ability of these proposals to address this crisis effectively, and about the burden that the American taxpayer potentially is being asked to carry."

Paulson said that if the government extends any financial backing to the two institutions it will be done "under terms and conditions that protect the U.S. taxpayer." He didn't provide details. "This is a backup facility that hopefully ... will never be used," Paulson said. The Treasury chief said he hoped that the pledge itself would help to boost eroding investor confidence in the companies.

Sen. Richard C. Shelby of Alabama, the panel's senior Republican, cautioned, "I fear that we're sitting on a financial powder keg." Officials may envision never using the powers, Shelby added, but "this is not an empty gesture.... what if they did?"

On the economic front, inflation has remained high and "seems likely to move temporarily higher in the near term," Bernanke warned.

Indeed, before Bernanke delivered his twice-a-year comprehensive economic assessment to Congress, the Labor Department reported wholesale prices jumped 1.8 percent in June. That left inflation rising over the past year at the fastest pace in more than a quarter-century.

"Given the high degree of uncertainty" about the Fed's economic outlook, Fed policymakers will need to carefully assess incoming information about inflation and economic growth, he said.

The Fed in June signaled an end to its nearly year long rate-cutting campaign because of growing concerns about inflation. Bernanke kept up his tough anti-inflation talk on Tuesday but stressed many other problems that could short circuit economic growth. He seemed to be keeping his options open in terms of rates. Given all the risky cross currents, economists believe the Fed will leave rates alone when they meet on Aug. 5.

Righting wobbly financial markets is key to getting the economy back on track, he said.

"In general, healthy economic growth depends on well-functioning financial markets," Bernanke said. "Consequently, helping the financial markets to return to more normal functioning will continue to be a top priority," he said.