Manageable Threats Seen by Fed Chief

March 29, 2007 Manageable Threats Seen by Fed Chief By JEREMY W. PETERS and EDMUND L. ANDREWS WASHINGTON, March 28 — Ben S. Bernanke, the Federal Reserve chairman, said Wednesday that he did not expect the escalating problems in the mortgage lending business to spread to the rest of the economy, but noted that the Fed had given itself the “flexibility” to adjust interest rates should the outlook change for better or for worse. In his first remarks on the economy since the Fed decided last week to leave interest rates unchanged, Mr. Bernanke did not stray far from the monetary policy statement the central bank issued with its decision. Inflation is still the predominant concern, and the economy does not appear to be in danger of slowing too much, he said in testimony to the Congressional Joint Economic Committee. To many analysts, the Fed appears on track to keep its main short-term interest rate steady, but investors appeared to read the comments as a sign that a cut in interest rates was somewhat less likely soon. Stock prices fell sharply as news media reported the substance of Mr. Bernanke’s prepared testimony. But they recovered some of that lost ground as he continued testifying through the morning. Still, Wall Street ended the day broadly lower as investors digested news of rising oil prices and modest orders of durable goods in February. The Standard & Poor’s 500-stock index declined 0.8 percent for the day, closing at 1,417.23, while the Dow Jones industrial average dropped 96.93 points, or nearly 0.8 percent as well, to 12,300.36. Mr. Bernanke, in his testimony and in responding to questions from lawmakers, offered a window into the Fed’s thinking, saying that growing doubts about which path the economy might take prompted the central bank to leave itself some room. “We are looking for a bit more flexibility, given the uncertainties that we are facing and the risks that are occurring on both sides of our outlook,” he said. Those uncertainties have “increased somewhat in recent weeks.” He was careful to hedge his remarks with a firm reiteration of the Fed’s inclination to raise rates, not lower them, given the high rate of inflation. “I do want to emphasize that we have not shifted away from an inflation bias,” he said. The hearing also allowed Mr. Bernanke to wade deeper into the discussion about whether the rising number of defaults among riskier borrowers — those with weak or subprime credit histories — threatened the nation’s overall economic vitality. Mr. Bernanke’s answer, in short, was probably not. In recent months, numerous subprime lenders have reported serious financial problems. As homeowner defaults have risen, dozens of small subprime lenders have gone out of business. Some lenders have filed for bankruptcy. Others have stopped issuing loans or tightened lending standards. Many economists have expressed concerns that trouble in the subprime market could worsen the slump in the housing market and, in turn, cause the economy to stall. But Mr. Bernanke said the Fed believed that was unlikely to happen. “The impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained,” he said. His picture of the economy was generally sanguine. The economy is likely to expand at a moderate pace this year and inflation is expected to decline slightly, he said. He expects business investment and consumer spending to continue to grow. Mr. Bernanke also weighed in on the issue of whether Congress should more closely regulate mortgage lenders. Some lawmakers have called for tighter restrictions on issuing loans to people with low incomes and weak credit. In the hearing on Wednesday, Senator Charles E. Schumer, Democrat of New York, said he planned to introduce legislation that would establish a national regulatory system for mortgage brokers. Mr. Bernanke said that he believed “it’s worth looking at” whether Congress should give the Fed the authority to enforce regulations on mortgage lenders that are not part of a banking institution. “Although we have the authority to pass these rules, we still have the enforcement issue,” he said. “Our enforcement powers do not extend beyond the banking system.” But broadly, the Federal Reserve chairman said that imposing government restrictions had the potential to damage the housing market. He said financial institutions were already tightening their lending standards, which would eventually bring the housing market back into balance. In the short term, though, tougher lending standards could further reduce the demand for housing and add to the bloated inventories of unsold homes. Democrats and Republicans on the Joint Economic Committee greeted Mr. Bernanke with blunt expressions of worry, particularly about troubles in the housing market. And they used the forum to advocate tougher legislation. “This is a terrible instance where a lack of oversight has led to a Wild West mentality among unscrupulous lenders and, frankly, the exploitation of large numbers of financially unsophisticated borrowers,” Mr. Schumer said. During the hearing, Mr. Bernanke was his usual self: cautious and economical with his words and at times cagey, never tipping his hand about what he thinks the Fed’s next move would be. Might Mr. Bernanke indulge the committee with a scenario under which the Fed might cut rates, asked Representative Carolyn B. Maloney, a Democrat from New York. The chairman politely declined. “I can’t tell you specifically what policy is going to do,” he said. James Knightley, an economist with ING Global Financial Markets, said: “While Bernanke seems to have made room for the possibility of policy easing with his more guarded prognosis for the U.S. economy, he continues to believe that inflation is the main threat to the economy.” “Therefore any imminent policy easing seems unlikely.”