Bernanke vows to protect nation's economy from a global credit crunch

~ Many people believe the Fed will cut the prime rate by one-quarter percentage point around Sept. 18.

JACKSON, Wyo. -- Federal Reserve chairman Ben Bernanke vowed Friday to do all that is necessary to protect the national economy from the ill effects of a global credit crunch -- but not to bail out investors and lenders "from the consequences of their financial decisions."

President Bush confidently predicted the country would safely weather the financial storm.

Friday's comments -- made in separate appearances -- by Bernanke here and the president in Washington, sought to send a reassuring but tough-love message: Fed policymakers and the Bush administration are on top of the situation that has unnerved investors on Wall Street and around the world and raised anxiety on Main Street. But they'll act in the best interests of the economy.

While Bush announced steps Friday to help homeowners struggling to make their mortgage payments, he made clear he has no interest in bailing out lenders, some of whom got cocky, took on too much risk and ended up with bad loans.

"The government's got a role to play, but it is limited," Bush said at the White House. "A federal bailout of lenders would only encourage a recurrence of the problem."

Strong economy

In anxiously awaited remarks, Bernanke suggested the Fed's next move will be driven by economic considerations, not only in response to troubles of investors and lenders.

"It is not the responsibility of the Federal Reserve -- nor would it be appropriate -- to protect lenders and investors from the consequences of their financial decisions," Bernanke said. "But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy."

Still, many believe the odds are growing that the Fed will cut its most important interest rate, now at 5.25 percent, by at least one-quarter percentage point on or before Sept. 18, its next regularly scheduled meeting. The Fed hasn't lowered this rate in four years.

The Fed "will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets," Bernanke told an economics conference here.

On Wall Street, stocks rose after Bernanke's remarks. The Dow Jones industrials were up more than 119 points at the market's close.

The fear is that if credit continues to become harder for people and businesses to get, spending and investment will be crimped. That could hurt overall economic growth. In a worst-case scenario, the country could slide into a recession. Credit is the economy's life blood. It enables people to finance big-ticket purchases such as homes and cars and can help businesses bankroll expansions and other things that can boost hiring.

Bush, however, predicted the economy would get through the financial crisis and urged patience.

Process takes time

"The markets are in a period of transition as participants reassess and reprice risk," the president said. "This process has been unfolding for some time, and it's going to take more time to fully play out. As it does, America's overall economy will remain strong enough to weather any turbulence."

Before the financial crisis erupted, the economy had a full head of steam, growing at a robust pace of 4 percent in the April-to-June quarter. But growth is expected to slow to half that pace in the current quarter and lose more speed in the final quarter of this year.

The unemployment rate, now at 4.6 percent, is expected to creep up to around 5 percent by the end of this year.

To guide the Fed in terms of what its next move will be, Bernanke said policymakers will pay especially close attention to the "timeliest indicators" as well as information gleaned from businesses and banks around the country.

Economic data that was taken before the credit markets really seized up in August will be much less useful to policymakers to assess the country's economic health, he explained.

It was his first speech -- and his most extensive comments -- since the credit crunch took a turn for the worst in August. The carnage in credit markets and the turmoil on Wall Street pose the biggest test of Bernanke's skills since taking the Fed helm 19 months ago.

The Fed's most important interest rate, called the federal funds rate, has been at 5.25 percent for more than a year. Any reduction to this rate would mean lower interest rates for millions of people and businesses. That's why it is the Fed's main tool for influencing economic activity.

After listening to Bernanke's speech, John Makin, principal at Caxton Associates Inc., believed the Fed was moving "a tiny bit closer" to a rate cut.

In his remarks to a high-profile conference here on housing sponsored by the Federal Reserve Bank of Kansas City, Bernanke discussed some of the steps the Fed has taken so far to deal with the credit crunch.

While problems were triggered largely by heightened concerns about higher-risk "subprime" mortgages made to people with blemished credit histories or low incomes, Bernanke said "global financial losses have far exceeded even the most pessimistic projections of credit losses on those loans."

To stabilize wobbly markets, the Fed on Aug. 17 sliced its lending rate to banks by a half percentage point to 5.75 percent. It also has pumped billions of dollars into the financial system to help banks and other institutions get through the credit hump and carry out their business.

The Fed's main concern, however, is the extent to which these problems might short-circuit economic growth.

"The further tightening of credit conditions, if sustained, would increase the risk that the current weakness in housing could be deeper or more prolonged than previously expected, with possible adverse effect on consumer spending and the economy more generally," Bernanke said.

After a five-year boom, the housing market went bust last year; problems are expected to persist well into next year as builders try to whittle down a glut of unsold homes.

During the housing slump, a combination of higher interest rates and weaker home values clobbered homeowners, especially those with blemished credit histories or low incomes holding higher-risk "subprime" loans.

With squeezed homeowners finding it impossible to make their mortgage payments or pay them in a timely fashion, foreclosures and delinquencies are soaring and are expected to get worse. Lenders have been forced out of business, and hedge funds and other big investors in subprime mortgage securities also have taken a big financial hit.

Very low initial "teaser" rates jumping to much higher rates as they reset are socking some homeowners. Analysts estimate 2 million adjustable-rate mortgages will reset this year and next. Steep prepayment penalties have made it difficult for some to get out of their mortgages. Some overstretched homeowners can't afford to refinance or even sell their homes.

A key element of Bush's plan would allow homeowners with a good credit history, but who cannot afford their mortgage payments, to refinance into mortgages insured by the Federal Housing Administration to keep from defaulting.

Most of the carnage has been in the subprime market, but problems have spread to other more creditworthy borrowers. That has sent investors into periods of panic in recent weeks, causing stocks on Wall Street to careen wildly.

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