Bernanke Sees Slowdown Into 2008
As U.S. Housing Slump Intensifies

Federal Reserve Chairman Ben Bernanke said that while the most recent data suggest a "resilient" economy, growth should slow "noticeably" this quarter and into 2008 as the housing slump intensifies.

Still, the economy should strengthen later next year, he said, and the Fed's recent rate reductions have put risks to growth and inflation roughly in balance.

His remarks suggest that, from a broad economic perspective, another rate reduction in December is unlikely, though he left the door open for future moves, saying the Fed will "act as needed" to foster sustained economic growth and low inflation.

Since last week's Federal Open Market Committee meeting, at which officials lowered the federal funds rate by a quarter percentage point to 4.5%, "the few data releases that have become available have continued to suggest that the overall economy remained resilient in recent months," Mr. Bernanke said in prepared testimony to the Joint Economic Committee of Congress

"However, financial market volatility and strains have persisted," he said, and investor concerns about housing and its implications on the broader economy have "intensified."

Mr. Bernanke said he also sees "important" upside inflation risks, citing higher oil and commodity prices and the dollar, which has "weakened."

Still, the Fed expects both overall and core inflation -- which excludes food and energy -- to stay in a "range consistent with price stability next year," Mr. Bernanke said, as inflation expectations have stayed "reasonably" anchored. But that could change, he cautioned, should those price expectations "become unmoored."

Officials have lowered the federal funds rate a total of three-quarters of a percentage point since September to limit the economic fallout from the housing and credit crunch. But in a statement last week, the Fed said it viewed upside inflation risks as roughly equal to downside growth risks, an assessment Mr. Bernanke repeated Thursday.

Comments this week by Fed governor Frederic Mishkin and Philadelphia Fed President Charles Plosser suggest officials aren't inclined to lower rates again when they meet next month.

Indeed, economic data suggest that, at least until now, the fallout from housing on the rest of the economy has been minimal. Gross domestic product advanced at a 3.9% rate last quarter, the government said last week, and data since then suggest that could be revised to well above 4%.

However, private-sector forecasters only expect the economy to grow around 1.5% this quarter, and the Fed acknowledged in last week's policy statement that growth is likely to slow.

At last week's meeting, policy-makers expected GDP "would slow noticeably in the fourth quarter from its third-quarter rate," Mr. Bernanke said, and that it will remain "sluggish" in the first part of next year before "strengthening" as the effects of the housing slump start to wane.

Meanwhile, Mr. Bernanke predicted that foreclosure rates would continue to rise and painted a grim picture of what such a development could have on the broader economy.

Particularly, Mr. Bernanke said subprime adjustable-rate mortgages posed the biggest threat, as it will be "much more difficult" than before for homeowners with these loans to afford the increased monthly payments.

"Delinquencies on these mortgages are likely to rise further in coming quarters as a sizable number of recent-vintage subprime loans experience their first interest rate resets," he said.

Mr. Bernanke said 450,000 subprime adjustable-rate mortgages per quarter are expected to reset into higher monthly payments each quarter until the end of 2008.

Mr. Bernanke said the number of foreclosures could be reduced if "financial institutions work with borrowers." The Fed and other regulators have stepped up pressure on loan servicers in recent weeks as studies have shown that early attempts to rework loans had minimal success.

"Foreclosure cannot always be avoided, but in many cases loss-mitigation techniques that preserve homeownership are less costly than foreclosure," he said.

Mr. Bernanke said that regulators should be watchful of how these loans are reworked.

"Although workouts are to be encouraged, regulators must be alert to ensure that they are done in ways to protect consumers' interests and do not disguise lenders' losses or impair safety and soundness," he said.

Mr. Bernanke reiterated his plan to issue a proposal by the end of the year that would create new standards and rules for all lenders that issue subprime loans. The Fed has had this authority for years but never used it.

As part of this proposal, Mr. Bernanke said the central bank was looking at certain prepayment penalties, stated-income loans, and "failure to give adequate consideration to a borrower's ability to repay," among other things.

"Because many investors had not developed the capacity to perform independent evaluations of these often-complex instruments, the loss of confidence in the credit ratings, together with uncertainty about developments in the housing market, led to a sharp decline in demand for these products," he said.