A mammoth stimulus package being crafted by  President-elect Barack Obama could give the economy a much-needed  lift, but other steps must be taken to bolster the wobbly financial  system and for any recovery to stick, Federal Reserve Chairman Ben  Bernanke said Tuesday. 

Specifically, Bernanke suggested the government inject more  money into banks. He also offered options to deal with rotten  mortgages and other bad assets held by financial institutions, a  problem that has contributed to a lockup in lending. Bernanke also  again called for the government to do more to curb home  foreclosures. 

The Fed chief’s extensive remarks, in a speech at the London  School of Economics, come at a critical time as the U.S. gets ready  to change its political and economic guard from President George W.  Bush to Obama next week. 

Bernanke said the roughly $800 billion recovery plan – a blend  of tax cuts and increased government spending – now being worked on  by Obama and the Democrat-controlled Congress could provide a  “significant boost” to the crippled economy. But he made clear  that such a plan must be part of a broader, multi-pronged  government response to fight the worst financial crisis the hit the  U.S. and the global economy since the 1930s. 

“Fiscal policy can stimulate economic activity, but a sustained  recovery will also require a comprehensive plan to stabilize the  financial system and restore normal flows of credit,” Bernanke  said. “History demonstrates conclusively that a modern economy  cannot grow if its financial system is not operating effectively.” 

To help on that front, the Fed is lending billions to financial  companies and buying mounds of companies’ debt to help bust through  the debilitating credit clog. And the Treasury Department is  overseeing a $700 financial bailout program that has pledged to  inject $250 billion into banks in return for partial government  ownership. Some government money also is being used to guarantee  against possible losses from risky assets held by Citigroup Inc. 

Bernanke said “more capital injections and guarantees may  become necessary” to stabilize financial markets and spur more  lending. If Obama’s incoming Treasury secretary Timothy Geithner  decides to remove toxic assets from financial institutions’ balance  sheets – the original but abandoned strategy under the $700 billion  bailout – Bernanke suggested some options to do that. 

Public purchases of the troubled assets are one way to go, he  said. Another option is to provide asset guarantees under which the  government would agree to absorb – presumably in exchange for  warrants or some other form of compensation – part of the  prospective losses on specified portfolios of rotten assets held by  banks. Yet another approach would be to set up and capitalize  so-called “bad banks,” which would buy assets from the financial  institutions in exchange for cash and equity in the bad bank. 

One of the most pressing decisions that Geithner will face is  exactly how to spend the second, $350 billion installment of the  bailout fund and whether to resurrect the strategy – shelved by  Bush’s Treasury secretary Henry Paulson – of buying toxic assets  held by banks. 

Obama’s transition team had no immediate comment Tuesday, but a  letter from his incoming economic adviser Lawrence Summers to  congressional leaders on Monday also called for a comprehensive  approach – beyond the stimulus package – to deal with the crisis. 

Some Americans and some on Capitol Hill have been upset about  Treasury’s management of the $700 billion program, which has  provided aid to financial companies and others on Wall Street -  some of whom are blamed for getting the country into economic the  mess in the first place – while other struggling industries get  little or no assistance. 

Bernanke said he understands this concern, but added: “This  disparate treatment, unappealing as it is, appears unavoidable.” 

The United States’ economic system is critically dependent on  the free-flow of credit, Bernanke said. It is like the economy’s  oxygen. As it has been cut off, the economy has sunk deeper into  recession, taking Americans’ jobs with it. 

Washington policymakers, Bernanke said, “must therefore do what  they can to communicate to their constituencies why financial  stabilization is essential for economic recovery and is therefore  in the broader public interest.” 

Obama’s political skills will be put to a high-stakes test with  Congress as he seeks assess to the second half of the $700 billion  bailout pot. Congress has a 15-day deadline to reject the request,  which Bush made on Obama’s behalf on Monday. 

Additional efforts to stem skyrocketing home foreclosures could  strengthen the collapsed housing market, which in turn would  buttress financial stability, Bernanke said. Obama also wants to  see more done to curb foreclosures. 

To cushion fallout from the recession, the Fed in December  slashed its key rate to an all-time low of between zero and 0.25  percent. The Fed signaled that it would keep rates at that level  for some time and pledged to use unconventional tools to revive the  economy. One such tool Bernanke again mentioned is the possibility  of the Fed buying longer-term Treasury securities. 

The central bank will meet later this month to assess economic  and financial conditions. 

Even as the U.S. battles the current crisis, it must move to  prevent future ones. To be effective, international cooperation is  needed, Bernanke said. 

“A clear lesson of the recent period is that the world is too  interconnected for nations to go it alone in their economic,  financial and regulatory policies,” Bernanke said. “International  cooperation is thus essential if we are to address the crisis  successfully and provide the basis for a healthy, sustained  recovery.” 

In time, the global economy will recover from the current  crisis, “but the timing and strength of the recovery are highly  uncertain,” he added. 

Bernanke, who earlier Tuesday met with British Prime Minister  Gordon Brown and Bank of England Governor Mervyn King, said he  expects to see “continued weakness” in the U.S. jobs market in  the first quarter of this year. The unemployment rate bolted to a  16-year high of 7.2 percent in December. For all of last year, 2.6  million jobs disappeared, the most since World War II.

“We are certainly in a very bad stage of contraction as far as  employment is concerned,” he said. 

However, he was hopeful of seeing some stabilization in the U.S.  economy later in 2009, depending on factors like improvements in  the credit market. “It isn’t rapid growth, but a stabilization and  a stop to the bleeding in some sense,” he said.