WASHINGTON — Federal Reserve Chairman Ben Bernanke signaled Wednesday that continued risks to economic growth could mean more interest-rate cuts, but he cautioned that rising oil prices are creating inflationary pressures that could handcuff efforts to spark the economy.
Testifying before the House of Representatives Financial Services Committee, the Fed chairman acknowledged that he faces competing demands. The Fed's forecast for sluggish economic growth calls for further lowering lending rates. But rising oil prices — now around $100 a barrel — and a rapid increase in food prices are pushing inflation higher, and that generally argues for higher interest rates.
"The incoming information since our January meeting continues to suggest sluggish economic activity in the near term," Bernanke said, stressing that risks to growth remain. "The risks include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further."
Translation: The Fed isn't sure what the future holds for the economy.
Bernanke admitted under questioning that the Fed faces "a difficult situation." The economy is slowing, inflation is rising and if those trends aren't enough, the slide in home prices and turmoil in mortgage markets show no sign of abating.
These developments threaten an economic vicious cycle in which declining home prices depress consumer confidence and dampen consumer spending, which drives two-thirds of U.S. economic activity.
"That's three difficult areas where the Fed has to worry about, three different fronts," Bernanke said. "That's the kind of balancing we have to do going forward."
Much of Wednesday's hearing focused on the struggling housing market, which is at the epicenter of today's economic downturn. As Bernanke testified, the regulator of government-sponsored lenders Freddie Mac and Fannie Mae announced that it would allow the two entities to lift the caps on the total size of their loan portfolios.
The Office of Federal Housing Enterprise Oversight said that as of Saturday it would eliminate the caps that it had established two years ago in response to accounting problems at the two lenders. That should allow Fannie Mae and Freddie Mac to take on more loans at a time when the private sector is having difficulty packaging loans into mortgage bonds, a process called securitization.
Lifting the caps is also important because the fiscal stimulus package that Congress passed and President Bush signed earlier this month calls for raising the limit on loan values that Fannie Mae can securitize. Lifting the caps and nearly doubling the value of loans are measures designed to help regions with high housing costs, such as California and the Northeast.
Asked about the developments, Bernanke suggested that they're welcome but gave only cautious praise.
"I think we're going to have to see. It's going to take a bit of time for them to get geared up," he said, adding that bond issuers are insisting on packaging high-value loans as separate products that won't be mixed in with the lower-value loans commonly bundled into mortgage bonds. "It remains unclear how much benefit will come from this."
News of the cap-lifting obscured the release of financial data Wednesday showing that Fannie Mae posted a $3.6 billion loss for the fourth quarter of 2007. Analysts expected Freddie Mac to disclose similar large quarterly losses Thursday.
Bernanke repeated that the Fed soon would take final action to strengthen its regulatory powers over all mortgage lenders. Expected measures include better disclosure of the terms of mortgages to borrowers, using third-party documents to verify borrowers' income for high-value home loans, requiring lenders to establish escrow accounts to collect taxes and insurance on high-cost loans, and limiting the use of prepayment penalties, which in recent years have been used to trap borrowers in high-cost loans.
Rep. Maxine Waters, D-Calif., complained to Bernanke that mortgage lenders and the Treasury Department aren't offering verifiable evidence that troubled borrowers are getting loan modifications. Bernanke acknowledged that he, too, is struggling to gauge the success of the Bush administration's Hope Now effort, which pushes lenders to rework loans and prevent foreclosures.
"You are quite right that the information has been quite mixed," the Fed chief said, noting that most of it is coming from the private sector and that the Fed is seeking independent data to gauge what's happening.
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