Housing's Hurt Spoils His View
Homeowners' 'Distress' Will Get Worse, Bernanke Says

By Nell Henderson
Washington Post Staff Writer
Thursday, July 19, 2007

Federal Reserve policymakers expect the slumping housing market to restrain U.S. economic growth this year and next, as more Americans fall behind in their mortgage payments and lose their homes to foreclosure, Chairman Ben S. Bernanke told Congress yesterday.

Home sales are likely "to remain sluggish for a time" while declining home construction "will likely continue to weigh on economic growth over coming quarters," Bernanke said in testimony to the House Financial Services Committee. "Rising delinquencies and foreclosures are creating personal, economic and social distress for many homeowners and communities -- problems that likely will get worse before they get better."

Bernanke, responding to criticism that the Fed should have done more to prevent the current mortgage market turmoil, devoted much of his testimony to describing the Fed's efforts to curb foreclosures and crack down on abusive lending practices.

Barney Frank (D-Mass.), the committee chairman, welcomed Bernanke's comments on consumer protection issues, calling them "a step forward" from the Fed chief's traditional focus on the economy and interest rate issues. "It was not Uncle Alan's semiannual report," Frank said, referring to Alan Greenspan, Bernanke's predecessor .

Bernanke's testimony reflected a slightly darker economic outlook than the one he and his colleagues shared in February, when he delivered the Fed's previous economic report to Congress. Then, many Fed officials expected the housing market to improve enough this spring that the economy would rebound by year end to its long-term average growth rate of about 3 percent. Now, most Fed officials expect the economy to continue to expand at a more moderate pace of around 2.5 percent through 2008.

Fed policymakers, however, have not changed their forecasts for inflation or unemployment. They expect inflation to ebb through next year, while joblessness ticks up to about 4.7 percent from its current 4.5 percent level.

Those projections and Bernanke's comments strengthened many analysts' expectations that the Fed is likely to hold short-term interest rates steady for the foreseeable future. The central bank has held its benchmark rate at 5.25 percent for a year, after lifting it steadily for two years to dampen inflation pressures.

Stock prices fell on the Fed's forecast for slower economic growth, which could depress profits. Bond prices rose as some investors bet that the Fed still might cut interest rates later this year.

Bernanke repeated that the Fed sees higher inflation as a greater risk than slow growth. "We have to be quite vigilant about inflation at this juncture," he said.

The Labor Department said yesterday that consumer prices rose 0.2 percent in June, held down by falling energy prices. The department's consumer price index, a widely followed inflation gauge, rose 2.7 percent in the 12 months ended in June.

Bernanke noted that so-called core inflation measures, which strip out food and energy prices, have improved. But he said it was too soon to know if the improvement is temporary or constitutes a trend. Moreover, he noted, "sizable increases in food and energy prices have boosted overall inflation and eroded real incomes in recent months -- both unwelcome developments."

Because food and energy prices have been volatile, core inflation measures may be better gauges of underlying inflation trends, he said.

Bernanke and several other officials have described their policy goals by saying they would seek to keep core inflation between 1 and 2 percent -- a range many investors have come to believe is the Fed's unofficial comfort zone. Core inflation was 1.9 percent in the 12 months that ended in May.

But yesterday, Bernanke said that "the Fed is concerned about the overall inflation rate" in the long term, and worries that persistently higher food and energy prices might cause consumers to expect, and thus cause, higher inflation. "We drive. We eat. We understand this," he said.

Several committee members pressed Bernanke on what they and the Fed could do to address growing U.S. income inequality.

"I think the single most pressing economic issue facing the country today is excess and growing inequality," Frank said.

Bernanke responded that the trend is more than 30 years old, and largely reflects advances in technology that favor more highly skilled workers, and globalization.

The Fed's best response, he said, is to maintain a steady and strong economy. Congress and other economic policymakers should focus on ways to strengthen educational and economic opportunities, while finding ways to assist workers seeking new skills and careers, he said.

Responding to questions from the committee, Bernanke also said hedge and private-equity funds and other private pools of investment capital provide "important benefits" for the economy by spreading financial risks and increasing liquidity in the markets.

The Fed chief suggested the boom in private corporate buyouts was a healthy trend. "In private equity in particular, they play an important role in the market for corporate control," he said. "We need to have a mechanism whereby poorly run companies' weak managements are subject to being taken over, replaced and their companies improved."