Remarks to Be First Since Credit Crunch
By Neil Irwin
Washington Post Staff Writer
Thursday, August 30, 2007
Tomorrow, Ben S. Bernanke will deliver the most important speech in his 19 months as the world's most powerful central banker.
In his first public comments since financial markets unraveled this month, the Federal Reserve chairman faces risks on all sides. If he seems indifferent to turmoil on Wall Street, markets could go haywire all over again. If he seems too eager to take actions to help the markets, it might encourage investors to behave irresponsibly in the future.
What he is likely to do, close watchers of Bernanke and the Fed said, is lay out his view that it is important to distinguish between prices of securities dropping and a breakdown in the markets. As Bernanke has explained in past speeches and writings, the Fed need not take action just because the prices of, say, complicated securities backed by mortgage debt have plummeted.
But the Fed does need to worry, in his view, when there is sustained panic and markets freeze up, as they did in early August, such that investors will not buy corporate debt or other assets at any price. The fear is that a credit crisis makes it difficult for sound businesses to invest or consumers to engage in day-to-day transactions.
"The chief characteristic of a financial panic is that investors lose their bearing," said Lyle Gramley, a former Fed governor who is now senior economic adviser to Stanford Washington Research Group. "They've become frightened. They don't know what to think about where things are going."
Wall Street will be scrutinizing every word for hints about whether the Fed will cut a key interest rate -- and if so, how much -- at a meeting of its policymaking committee Sept. 18. Trillions of dollars in trades hang on every comma. But Bernanke's past practice has been to deal with such questions obliquely, and Fed watchers say he is highly unlikely to lay out specific new policy steps for the central bank.
The Fed's next big move depends heavily on what happens in financial markets and the economy from now to its Sept. 18 meeting. And interpreting that information will be tricky.
The Federal Open Market Committee, which sets the central bank's policy on interest rates, typically relies heavily on a sophisticated computer model that projects where the U.S. economy is heading. Several committee members have customized versions of the model, which they use to develop their personal projections.
But such models are not terribly useful in times of financial crisis, economists say. Most of the data are weeks or months old, and in moments of turmoil, the economy tends to shift in unpredictable ways.
Fed policymakers will also be listening carefully to the presidents of the 12 regional Federal Reserve banks around the country. Each president is in frequent contact with business leaders in his or her region.
If the regional bank presidents report that their business contacts view the problems in credit markets to be confined to Wall Street, the Fed will feel little pressure to act. If, on the other hand, they report that their access to capital has been choked off or that consumer spending is slowing, that would weigh heavily as a reason for the Fed to cut the federal funds rate or take other aggressive action.
To the degree that they can use economic data to decide about a rate cut, Fed policymakers might look closely to more arcane data than that which normally shapes their decision-making.
Companies tend to be slow to lay off employees when hard times hit, but they are quicker to cease hiring. Similarly, workers are disinclined to quit when there are few openings elsewhere. So in the early phases of a downturn, job growth remains steady and the unemployment rate does not change, even as fewer people are switching jobs.
That shows up in the Labor Department's job openings and labor-turnover report, published each month. If the July report, to be released Sept. 11, shows that the nation's job market was starting to freeze up, it could be a sign of trouble.
Each Thursday, the Labor Department reports how many workers filed for initial unemployment benefits in the previous weeks, an early but volatile sign of widespread job cuts. There were 322,000 such claims last week, a number that does not raise alarm bells among economists.
Consumer confidence and other survey data show how market problems are affecting peoples' views. On Tuesday, the Conference Board said its consumer confidence measure fell to the lowest level in two years.
"What the Fed does is very scenario-driven," said Peter Hooper, chief economist of Deutsche Bank Securities who previously was on the Fed staff. "A September rate cut would be driven by a feeling that confidence has really taken a hit."
But that measure can plummet without necessarily meaning the economy is on the rocks, as was the case following Hurricane Katrina.
Fed policymakers are not particularly interested in the exact level of the Dow Jones industrial average or the interest rate for a jumbo mortgage. Rather, they focus on whether transaction volume in troubled credit markets is increasing. They would like the difference between what buyers of assets are willing to pay and what sellers will accept, known as the "bid-ask spread," to narrow.
Assuming he follows his past practice, Bernanke, in his speech, is expected to take an academic approach, as befits a man who was a college professor for 23 years. He is likely explain the intellectual prism through which he is inclined to make decisions in the months ahead, not what those decisions will be.
"Instead of talking about the contemporary flashpoint, it will be a scholarly disquisition," said Alan S. Blinder, a Princeton University economist and former Fed vice chairman. "I don't expect to hear out of his mouth the words BNP Paribas, Countrywide, Bear Stearns, or any of that," he said, referring to companies that have been central to the recent market fluctuations.
"He doesn't want to rock a lot of boats," Blinder said. "One objective is not to make news."
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