Fed may keep open lifeline to financial firms

NEW YORK (Reuters) - Federal Reserve Chairman Ben Bernanke said on Tuesday the U.S. central bank might keep open a lifeline to financial firms, while the latest data showed distress in the housing and retail sectors continues.

Bernanke promised to consider retaining an emergency lending facility for Wall Street firms past year-end, showing the Fed is determined to stop the housing-inspired credit crisis from wreaking further havoc on the economy.

Investors have lived in constant fear of yet another eruption of credit turmoil, which started last year when it became clear that the bursting of the U.S. housing bubble was causing severe losses across financial markets.

"The presumption was that (Fed officials) were going to wind down the lending programs if and only if credit conditions improve. Obviously that has not been the case," said William O'Donnell, director of interest rate strategy at UBS Securities LLC in Stamford, Connecticut.

"Money has become dear despite their efforts. The problems seem to be elevated and are actually creeping higher."

U.S. Treasury Secretary Henry Paulson said home foreclosures may hit 2.5 million this year, many of them the borrowers' own fault for taking out loans they could not afford.

JPMorgan Chase & Co Chief Executive Jamie Dimon said simply because some problems in the credit markets have been resolved does not mean market conditions will not get worse.

HOUSING, RETAIL, HURTING

Pending sales of previously owned homes plummeted 4.7 percent in May, and sales at chain stores, though improved last week, were weaker in June.

Stocks rose on Wall Street, cheered by a drop in oil prices rather than the economic data, and the dollar gained. Longer-dated U.S. government bonds, which perform better during times of economic weakness, rose.

Economists polled ahead of the home sales report had expected a 2.8 percent decrease in the National Association of Realtors index.

Compared with a year ago, pending sales, which are based on contracts signed in May, were down 14 percent.

"The U.S. housing market is still not on the verge of a recovery," said David Watt, currency strategist at RBC Capital Markets, in Toronto.

The decline in home sales was far more than expected and was just the latest reminder that the economy's current troubles originated in the housing market.

A private report on sales at chain stores showed retail sales were struggling as the economy sags under the weight of the housing slump.

U.S. chain store sales rose 2.9 percent in the week ended July 5 versus the year-ago week, Redbook Research said, and sales fell 0.5 percent in June versus May.

However, concerns about the health of the U.S. financial sector eased somewhat after the regulator of mortgage financiers Fannie Mae and Freddie Mac played down the impact of a proposed accounting change.

Markets have feared the two government-sponsored entities might face capital constraints. But their regulator, the Office of Federal Housing Enterprise Oversight, said the accounting change that may affect trillions of dollars of mortgage bonds issued by Fannie and Freddie should not dictate capital requirements at the companies.

Taken literally, the change could mean Fannie Mae and Freddie Mac would need a combined $75 billion in additional capital, according to Lehman Brothers.

FED CONSIDERING OPTIONS

In remarks to a mortgage lending forum sponsored by the Federal Deposit Insurance Corp, Bernanke said credit costs have been driven higher and the pace of U.S. economic growth also has been hurt by market turmoil.

"We are currently monitoring developments in financial markets closely and considering several options, including extending the duration of our facilities for primary dealers beyond year-end, should the current unusual and exigent circumstances continue to prevail in dealer funding markets," Bernanke said.

The Fed set up the so-called Primary Dealer Credit Facility, or PDCF, in March as part of its effort to facilitate the purchase of ailing investment bank Bear Stearns by JPMorgan Chase & Co. It said at the time the PDCF would continue for at least six months.

The lending program allows primary dealers -- the biggest firms that deal directly with the Fed -- to borrow directly from the Fed at the discount rate, currently 2.25 percent.

(Reporting by Burton Frierson; Editing by Dan Grebler)