Fed's Pianalto sees housing key to turnaround

By Ros Krasny

DAYTON, Ohio (Reuters) - An end to the housing market bust and the huge declines in housing values is a prerequisite to turning the U.S. economy around, Cleveland Federal Reserve President Sandra Pianalto said on Thursday.

Pianalto said the economy faces "challenging times" but that "these stressful periods will abate," adding that the Fed has been responding to the economic slowdown and financial market crisis "with timely actions."

For now, though, ongoing declines in home prices are "very detrimental to our economy" and have spilled over into retail spending and consumer confidence about the future outlook, Pianalto said.

Even while addressing a crisis, the Fed needs to take its dual mandate -- maximum sustainable growth, and price stability -- into account, she added.

Still, Pianalto, a voting member of the Federal Open Market Committee in 2008, mostly steered clear of the economic and monetary policy outlook in her comments at the RISE investment forum at the University of Dayton.

For now, the "final grade" is not yet in on how well the central bank is steering its way through the ongoing liquidity crisis in the banking system, Pianalto told an audience of college students -- adding that she would assess herself an "A" for effort.

Pianalto said the Fed has been forced to broaden its policy arsenal in order to minimize the effects of the crisis on a vulnerable economy.

The various moves by the Fed to pump liquidity into the financial system, while innovative and even controversial, are within the parameters intended when the Federal Reserve system was created, she said.

Asked about the Fed's role in JPMorgan Chase & Co's buy-out of troubled investment bank Bear Stearns, Pianalto said that "not a dollar of taxpayer money" has been spent in backing the deal.

Pianalto said traditional policy mechanisms, which seemed to be working as recently as November, ultimately proved inadequate as the credit crisis deepened.

"Unusual circumstances call for creative policy responses," she said.

Subsequent policy moves have been "designed to bolster market liquidity and promote orderly market functioning," she said. "Liquid, well-functioning markets are essential for promoting financial stability and economic growth."

Since the crisis first erupted last summer, the Fed has not only slashed its benchmark interest rate to 2.25 percent from 5.25 percent but injected hundreds of billions of dollars into the ailing financial system.

In addition, the Fed has taken the unorthodox step of accepting depreciated mortgage-backed bonds as collateral for short-term lending, a move that some fear may put the central bank in a difficult position over time.

"Collectively, these innovations provide for much longer terms of lending, broader types of collateral, a wider class of counterparties, and a tighter spread between the primary credit rate and the target federal funds rate," said Pianalto.