Bernanke: Fed Ready To Act If Turmoil Hits Economy

JACKSON HOLE, Wyoming - The Federal Reserve will take the necessary steps to shelter the economy from turmoil in financial markets but will not bail out investors who made mistakes, Fed Chairman Ben Bernanke said on Friday.

"The committee continues to monitor the situation and will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets," Bernanke told a symposium organized by the Kansas City Federal Reserve Bank.

However, in a clear caution that policy-makers will not rescue Wall Street, Bernanke said the central bank should not shield investors from self-inflicted loss.

"It is not the responsibility of the Federal Reserve -- nor would it be appropriate -- to protect lenders and investors from the consequences of their financial decisions," he said.

This was an important reference to the moral hazard policy-makers run if they insulate financial markets from errors, hence encouraging more risk-taking. However, he acknowledged the Fed had wider obligations.

"Developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy," he said.

Bernanke's remarks came as President George W. Bush announced proposals aimed at helping borrowers avoid defaulting on loans.

Stock markets rallied by afternoon as the White House and the Fed showed readiness to address problems in financial and housing markets. U.S. Treasury debt prices fell as investors ventured away from safer investments.

Financial markets have been reeling from the effects of declining home prices and revelations of broad exposure to subprime loans. Losses in mortgage markets have led to a tightening of credit and volatile stock markets around the world in recent weeks.

Bernanke acknowledged that disruptions in markets stemming from a slumping housing market and a sharp rise in delinquencies from subprime loans could hurt the overall economy.

Those distortions would affect the Fed's thinking, he said.

"He was pretty well balanced -- he said they'll act as necessary but won't bail people out of bad decisions they've made. We have to wait for more data," said Ezechiel Copic, senior currency analyst for IDEAglobal in New York.

The Fed chairman said economic data shows the U.S. economy continued to expand moderately into the summer, in spite of sharp declines in housing markets.

However, he noted that conditions had since shifted due to events in financial markets, lifting the degree of uncertainty under which the Fed would have to chart policy.

"In light of recent financial developments, economic data bearing on past months or quarters may be less useful than usual for our forecasts of economic activity and inflation.

"Consequently, we will pay particularly close attention to the timeliest indicators, as well as information gleaned from our business and banking contacts," he said.

In his remarks, Bernanke distinguished between tools available to the Fed specifically to ease credit flows -- such as lowering the discount rate -- and actions it could take to boost the broader economy, such as cutting the benchmark federal funds rate.

The Fed would act if required to provide liquidity, he said, but he also added that the central bank would take steps to limit damage to the broad economy.

Some analysts saw the speech as bringing the Fed a little closer to lowering benchmark borrowing costs by a quarter-percentage point at its September 18 meeting, if not sooner.

Interest rate futures markets are signaling that investors believe the Fed will cut its target for the overnight federal funds rate by a quarter point to 5 percent.

"A big theme is that housing can do a lot to affect the business cycle," said John Makin of Caxton Associates, a New York hedge fund. "The speech increased the probability of a 25 basis points move in September."

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