Be The Intelligent Investor

Home Woes May Take Further Toll
Bernanke Warns DownturnLikely to Hamper GrowthThrough Early Next Year
By SUDEEP REDDYOctober 16, 2007
Two weeks before the Federal Reserve's next meeting on interest-rate policy, Fed Chairman Ben Bernanke said yesterday the economy is performing much as expected: The housing market is continuing to deteriorate, but financial markets are under less stress in the wake of the central bank's actions last month.
In a speech to the New York Economic Club, Mr. Bernanke said the housing downturn is likely to remain "a significant drag" on economic growth through early 2008. He said that strong income growth has so far propped up consumer spending even in the face of signs -- which he called "quite tentative" -- of a cooling labor market.
• The News: Federal Reserve Chairman Ben Bernanke said pressure on financial markets has been reduced since the recent turmoil, increasing the likelihood of moderate economic growth. While the housing sector continues to deteriorate, income growth is propping up consumer spending.
• What's Next: Fed officials don't appear inclined to cut rates further without signs that the housing downturn is spilling over into consumer or business spending.
"It remains too early to assess the extent to which household and business spending will be affected by the weakness in housing and the tightening in credit conditions," he said, according to the prepared text of his remarks.
His remarks indicate Fed officials will keep a close eye on data to gauge the condition of the economy but didn't suggest an inclination to cut interest rates further when policy makers meet on Oct. 30 and Oct. 31. The Fed on Sept. 18 lowered its target for the benchmark federal-funds rate to 4.75% from 5.25%, the first cut in four years, in an attempt to prevent a broader economic downturn fueled by the housing sector's sharp decline and credit-market turmoil.
The Fed's action sparked a rise in stock prices, which hit a record last week, and eased pressure in the credit markets. At the same time, consumer prices have faced "moderate increases" despite higher costs for oil and other commodities and a weaker dollar.
Mr. Bernanke said the improvement in the financial markets "increases the likelihood of achieving moderate growth" in the economy, while keeping prices stable. He cautioned that "considerable strains remain" in financial markets. He also acknowledged the risk of reducing rates -- a nod to concerns that such moves will encourage some investors to take even more risks.
"In such situations, one must also take seriously the possibility that policy actions that have the effect of reducing stress in financial markets may also promote excessive risk-taking and thus increase the probability of future crises," Mr. Bernanke said.
Still, he said, investors who made those risky bets in housing, through subprime mortgages for people with weaker credit, "have sustained significant losses" and mortgage firms that issued the loans have failed.
More fallout is expected from the housing downturn. The decline in residential construction has directly shaved three-quarters of a point off economic growth for the last year and a half. Tighter standards for mortgages are expected to depress construction activity further while also pushing prices lower.
The housing downturn hadn't led to "significant spillovers" into household and business spending as of the Fed's September meeting, Mr. Bernanke said. He said financial markets and consumers could still take a hit as a result. "Investors are continuing to reassess the risks they face and have not yet fully regained confidence in their ability to accurately price certain types of securities," he said. "The ultimate implications of financial developments for the cost and availability of credit, and thus for the broader economy, remain uncertain."

From wallstreetjournal on-line