Business

Bernanke: Financial storm not over

Federal Reserve Chairman Ben Bernanke said Friday the financial crisis that has pounded the country – coupled with higher inflation – is taking a toll on the economy and poses a major challenge to Fed policymakers as they try to restore stability.

“Although we have seen improved functioning in some markets, the financial storm that reached gale force” around this time last year “has not yet subsided, and its effects on the broader economy are becoming apparent in the form of softening economic activity and rising unemployment,” Bernanke said in a speech to a high-profile economics conference here.

While Bernanke welcomed the recent drops in oil and other commodities' prices, and said he believes inflation will moderate this year and next, the Fed chief also warned the inflation outlook remains highly uncertain.

The Fed, he said, would monitor the situation closely and will “act as necessary” to make sure that inflation doesn't get out of hand.

Wall Street seemed heartened by his outlook on inflation, with the Dow Jones industrial average rising nearly 200 points Friday. A drop in oil prices also contributed to the big climb.

Bernanke acknowledged that the current financial and economic environment is one of the most challenging to Fed policymakers “in memory.”

Given the dueling economic cross-currents – weak economic growth and higher inflation – many economists believe the Fed will leave rates where they are at its next meeting Sept. 16, and probably through the rest of this year.

“They won't act until the coast is clear on financial stability and the state of the economy,” said Allen Sinai, chief global economist at Decision Economics Inc. Many fear the economy will hit a rough patch later this year as the bracing effect of the government's tax-rebate checks fades.

The economy is the top concern for voters and of keen interest to presidential contenders Barack Obama and John McCain, who are gearing up for their party's conventions. Financial and credit problems are expected to smolder into next year. And, the unemployment rate, which jumped to a four-year high of 5.7 percent in July, is expected to keep rising.

The bulk of Bernanke's speech dealt with the need to bolster oversight of the nation's financial system to make it better able in the future to withstand future shocks.

To that end, Bernanke recommended that regulators work on ways to assess the health of the entire financial system, rather than the condition of individual banks, Wall Street investment firms or other financial companies – as is currently the focus.

“Such an approach would appear well justified as our financial system has become less bank-centered,” he said. “Some caution is in order, however, as this more comprehensive approach would be technically demanding and possibly very costly both for the regulators and the firms they supervise.” He added that “stress tests” for a range of financial firms might also be helpful.

Bernanke's remarks come amid renewed worries on Wall Street about the financial health of Fannie Mae and Freddie Mac. The mortgage giants' stocks have gotten hammered this week as investors became increasingly convinced a government bailout is inevitable.

Although the Fed chief didn't mention the companies, he said one of the critical questions facing the country is how to strengthen the financial system and at the same time protect against “moral hazard,” where financial companies might feel more inclined to gamble with risks because they believe the Fed or the government will bail them out.

  Comments