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Executive Summary:

Bernanke, in his testimony before congress today, admits that the economy has worsened since August in the wake of sub-prime loan defaults which would increase over coming months.  He also hinted that the present credit crisis could become a fully blown recession.

Internationally, China has suggested it may react by diversifying its $1.43 trillion in foreign exchange reserves into stronger currencies, and French President Sarkozy said that America’s ”monetary disorder risked turning into economic war” as American exports cheapened and European exports were becoming more expensive.

Bernanke’s appearance before congress was opened with a statement from New York Senator Charles Schumer, the chairman of the Joint Economic Committee. 

He said that in the aftermath of the “seizing up of the credit markets” in the summer, “there is now a lack of confidence in credit-worthiness throughout the market… However, while we did weather that summer storm, I’m very concerned that there may be a bigger storm on the horizon. Quite frankly, I think we are at a moment of economic crisis stemming from four key areas: falling housing prices, lack of confidence in credit-worthiness, the weak dollar and high oil prices. Each of these problems alone would be enough of a threat to our economic well-being. But taken together, they are essentially the four horsemen of economic crisis…

“Even our bedrock assumptions are being put into doubt. As housing prices decline, there are real fears that we won’t be able to depend on consumers, the engine of our economy over the past few years, to keep spending. And now we hear that foreign investors may no longer be confident in the dollar as the global currency of choice. I’m not surprised to hear experts, such as your predecessor Alan Greenspan, warn about the threat of recession. I’ve begun to worry about worse.

“In particular, as I watch bank after bank write down bad investments tied to baroque financial instruments that even sophisticated investors don’t understand, I fear for the stability of our financial system.”