by Calculated Risk on 6/03/2008 10:49:00 AM

From Fed Chairman Ben Bernanke: Remarks on the economic outlook

On the sources of the financial turmoil:

Although the severity of the financial stresses became apparent only in August, several longer-term developments served as prologue for the recent turmoil and helped bring us to the current situation.

The first of these was the U.S. housing boom, which began in the mid-1990s and picked up steam around 2000. Between 1996 and 2005, house prices nationwide increased about 90 percent. During the years from 2000 to 2005 alone, house prices increased by roughly 60 percent--far outstripping the increases in incomes and general prices--and single-family home construction increased by about 40 percent. But, as you know, starting in 2006, the boom turned to bust. Over the past two years, building activity has fallen by more than half and now is well below where it was in 2000. House prices have shown significant declines in many areas of the country.

A second critical development was an even broader credit boom, in which lenders and investors aggressively sought out new opportunities to take credit risk even as market risk premiums contracted. Aspects of the credit boom included rapid growth in the volumes of private equity deals and leveraged lending and the increased use of complex and often opaque investment vehicles, including structured credit products. The explosive growth of subprime mortgage lending in recent years was yet another facet of the broader credit boom. Expanding access to homeownership is an important social goal, and responsible subprime lending is beneficial for both borrowers and lenders. But, clearly, much of the subprime lending that took place during the latter stages of the credit boom in 2005 and 2006 was done very poorly.

A third longer-term factor contributing to recent financial and economic developments is the unprecedented growth in developing and emerging market economies. From the U.S. perspective, this growth has been a double-edged sword. On the one hand, low-cost imports from emerging markets for many years increased U.S. living standards and made the Fed's job of managing inflation easier. Moreover, currently, the demand for U.S. exports arising from strong global growth has been an important offset to the factors restraining domestic demand, including housing and tight credit. On the other hand, the rapid growth in the emerging markets and the associated sharp rise in their demand for raw materials have been--together with a variety of constraints on supply--a major cause of the escalation in the relative prices of oil and other commodities, which has placed intense economic pressure on many U.S. households and businesses.
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The current economic and financial situation reflects, in significant part, the unwinding of two of these longer-term developments--the housing boom and the credit boom--and the continuation of the pressure of global demand on commodity prices.

And on the dollar and inflation:

The challenges that our economy has faced over the past year or so have generated some downward pressures on the foreign exchange value of the dollar, which have contributed to the unwelcome rise in import prices and consumer price inflation. We are attentive to the implications of changes in the value of the dollar for inflation and inflation expectations and will continue to formulate policy to guard against risks to both parts of our dual mandate, including the risk of an erosion in longer-term inflation expectations.

It unusual for a Fed Chairman to comment so directly on the dollar, and this probably means rate cuts are off the table for now - even if the economy weakens further.