- The Washington Times - Friday, August 22, 2008

JACKSON, Wyo. (AP) – Federal Reserve Chairman Ben Bernanke said Friday the financial crisis that has pounded the country – coupled with higher inflation – is taking a toll on the economy and poses a major challenge to Fed policymakers as they try to restore stability.

“Although we have seen some improved functioning in some markets, the financial storm that reached gale force” around this time last year “has not yet subsided, and its effects on the broader economy are becoming apparent in the form of softening economic activity and rising unemployment,” Bernanke said in a speech to a high-profile economics conference here.

Although Bernanke welcomed the recent drops in prices for oil and other commodities, and believes inflation will moderate this year and next, the Fed chief said the inflation outlook remains highly uncertain.

The Fed, he said, would monitor the situation closely and will “act as necessary” to make sure that inflation doesn’t get out of hand.

The current financial and economic environment is one of the most challenging to Fed policymakers “in memory,” he acknowledged.

Given those dueling economic cross-currents– weak economic growth and higher inflation – many economists believe the Fed will leave rates where they are at its next meeting on Sept 16 and probably through the rest of this year.

The bulk of Bernanke’s speech dealt with the need to bolster oversight of the nation’s financial system to make it better able in the future to withstand future shocks.

To that end, Bernanke recommended that regulators work on ways to assess the health of the entire financial system, rather than the condition of individual banks, Wall Street investment firms or other financial companies – as is currently the focus.

“Such an approach would appear well justified as our financial system has become less bank centered,” he said. “Some caution is in order, however, as this more comprehensive approach would be technically demanding and possibly very costly both for the regulators and the firms they supervise,” he added.

He also said that “stress tests” for a range of financial firms might also be helpful.

Bernanke’s remarks come amid renewed worries on Wall Street about the financial health of Fannie Mae and Freddie Mac. The mortgage giants’ stock has gotten hammered this week as investors became increasingly convinced a government bailout is inevitable.

Although the Fed chief didn’t mention the companies, he said that one of the critical questions facing the country is how to strengthen the financial system and at the same time protect against “moral hazard,” where financial companies gamble with risks because they believe the Fed or the government will ultimately bail them out.

“Some particularly thorny issues are raised by the existence of financial institutions that may be perceived as `too big to fail’ and the moral hazard issues that may arise when governments intervene in a financial crisis,” he said.

Mitigating that problem is another challenge facing policymakers, he said.

This year’s Fed conference examines past and present financial crises, and the challenges confronting Bernanke and other central bankers as they try to help stabilize financial markets worldwide.

The Fed’s handling of the credit, financial and housing debacles is likely to spur debate at the forum, which is sponsored by the Federal Reserve Bank of Kansas City and draws Fed policymakers, economists, academics and international central bank officials.

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