Bernanke's prepared speech to housing group

WASHINGTON (Reuters) - Federal Reserve Chairman Ben Bernanke's speech on "Financial Markets, the Economic Outlook, and Monetary Policy," before the Women in Housing and Finance and Exchequer Club:

" Since late last summer, the financial markets in the United States and in a number of other industrialized countries have been under considerable strain. The turmoil has affected the prospects for the broader economy, principally through its effects on the availability and terms of credit to households and businesses. Financial market conditions, in turn, have been sensitive to the evolving economic outlook, as investors have tried to assess the implications of incoming economic information for future earnings and asset values. These interactions have produced a volatile situation that has made forecasting the course of the economy even more difficult than usual. In my remarks today I will provide some perspective on recent developments in the economy and financial markets, focusing on conditions in the United States. I will then discuss the Fed's recent policy actions and our plans for addressing the economic and financial challenges ahead. Housing, the Subprime Mortgage Market, and the Financial Turmoil As you will recall, the U.S. economy experienced a mild recession in 2001. During the ensuing recovery, above-trend growth was accompanied by rising rates of resource utilization, particularly after the expansion picked up steam in mid-2003. Notably, the civilian unemployment rate declined from a high of 6.3 percent in June 2003 to 4.4 percent in March 2007. As the economy approached full employment, the Federal Open Market Committee (FOMC), the monetary policymaking arm of the Federal Reserve System, was faced with the classic problem of managing the mid-cycle slowdown--that is, of setting policy to help guide the economy toward sustainable growth without inflation. With that objective, the FOMC implemented a sequence of rate increases, beginning in mid-2004 and ending in June 2006, at which point the target for the federal funds rate was 5.25 percent--a level that, in the judgment of the Committee, would best promote the policy objectives given to us by the Congress. The economy continued to perform well into 2007, with solid growth through the third quarter and unemployment remaining near recent lows. Indicators of the underlying inflation trend, such as core inflation, showed signs of moderating. However, the situation was complicated by a number of factors. Continued increases in the prices of energy and other commodities, together with high levels of resource utilization, kept the Committee on inflation alert. But perhaps an even greater challenge was posed by a sharp and protracted correction in the U.S. housing market, which followed a multiyear boom in housing construction and house prices. Indicating the depth of the decline in housing, according to the most recent available data, housing starts and new home sales have both fallen by about 50 percent from their respective peaks. In all likelihood, the housing contraction would have been considerably milder had it not been for adverse developments in the subprime mortgage market. Since early 2007, financial market participants have been focused on the high and rising delinquency rates of subprime mortgages, especially those with adjustable interest rates (subprime ARMs). Currently, about 21 percent of subprime ARMs are ninety days or more delinquent, and foreclosure rates are rising sharply. Although poor underwriting and, in some cases, fraud and abusive practices contributed to the high rates of delinquency that we are now seeing in the subprime ARM market, the more fundamental reason for the sharp deterioration in credit quality was the flawed premise on which much subprime ARM lending was based: that house prices would continue to rise rapidly. When house prices were increasing at double-digit rates, subprime ARM borrowers were able to build equity in their homes during the period in which they paid a (relatively) low introductory (or "teaser") rate on their mortgages. Once sufficient equity had been accumulated, borrowers were often able to refinance, avoiding the increased payments associated with the reset in the rate on the original mortgages. However, when declining affordability finally began to take its toll on the demand for homes and thus on house prices, borrowers could no longer rely on home-price appreciation to build equity; they were accordingly unable to refinance and found themselves locked into their subprime ARM contracts. Many of these borrowers found it difficult to make payments at even the introductory rate, much less at the higher post-adjustment rate. The result, as I have already noted, has been rising delinquencies and foreclosures, which will have adverse effects for communities and the broader economy as well as for the borrowers themselves.