Bernanke - “uncertainty surrounding outlook greater than normal”
Bernanke acknowledges subprime is root of recent financial market volatility with consequences for performance of the broader economy. U.S. economic growth has been pared by about 3/4 of a point in the last 1.5 years due to the housing market decline and further market declines are expected. Bernanke says outlook for home sales and construction are dependent on developments in the mortgage marekt; specifically, the tightening of rates for subprime and jumbo borrowers, the 2 most affected groups thus far. Adjustable rate mortgage deliquencies are running at 13.5% in June, double the June 2005 figure. ARMs originated in 2005-2006 are performing the worst due in part to further loosening of lending standards, specifically high LTVs and no documentation; deliquencies are likely to increase in these loans.
Bernanke traces the problem from deliquencies to mortgage lenders to their lenders - those issueing asset backed commercial paper as bridge loans and ultimately to the seemingly unrelated corporate paper market. Bernanke acknowledges financial markets believe that “credit risks might be larger and more pervasive” and that markets have become “increasingly impaired”.
Bernanke, after outlining what has been done to ease credit crunch - discount window and securities lending rate cuts - says the FED stands ready to “take additional actions to provide liquidity and promote the orderly functioning of the markets”. However, in the next breath Bernanke brings hope for a rate hike to earth, noting “It is not the responsibilty of the Federal Reserve to protect lenders and investors from teh consequences of their financial decisions”. He then swings in with “BUT, developments in financial markets can have broad economic effects felt by many outside the markets” and the FED takes those into account.
Bernanke says economic data from previous months may not be as useful in forecasting coming months so the FED will focus it’s attention on “the timeliest indicators”. In short, upcoming economic data will be emphasized rather than past performance. The Chairman also notes that sectors other than housing have been performing well. He wonders about the effect of home equity and cash out refinancing and their effects on consumer spending, noting that consumer house related liquidity could “smooth consumption over time”, reducing consumer dependence on spending current income (recent savings data somewhat support this view) .