Federal Reserve & Interest Rates

Federal Reserve Board Chairman Ben S. Bernanke commented on the current United States economic outlook and the recent actions of the Federal Open Market Committee at the end of October in his testimony on November 8, 2007.

The Gross Domestic Product (GDP) grew at an average pace of nearly 4 percent during the second and third quarters.  While it is true that increases in energy prices might lead to a rise in overall inflation, core inflation has modestly improved.  Investor concerns about the credit quality of mortgages triggered some financial turmoil.  Uncertainty about developments in the housing market and a loss of confidence in credit ratings as a reliable risk assessment lead to a sharp decline in demand in this area.

Chairman Bernanke stated that “Increased investor scrutiny of structured credit products is likely to lead ultimately to greater transparency in these products and to better differentiation among assets of varying quality.  Investors have also become more cautious and are demanding greater compensation for bearing risk.  In the short term, however, these events do imply a greater measure of financial restraint on economic growth as credit becomes more expensive and difficult to obtain. “

At the latest FOMC meeting, there was evident of strong growth in employment and income gains, and therefore consumer spending.  Despite this growth, the FOMC considered the mortgage lending issues, and the data that suggested that banks had tightened terms and standards regarding credit products.

Downside risks, including failing financial market conditions and large inventories of unsold homes were contributing factors in the recent federal funds rate reduction action.  Inflation continues to be a concern for the Fed, however, in order to “forestall some of the adverse effects on the broader economy,” they decided to make another cut in the rates.

Lending practices and constantly being monitored and evaluated.  The Federal Reserve and Congress and working with the Federal Housing Administration (FHA) and NeighborWorks America to help prevent delinquency.  The Conference of State Banking Supervisors (CSBS) are also involved in assisting subprime mortgage lenders and borrowers to get loan repaid.

Bernanke stated, “We are looking closely at practices such as prepayment penalties, failure to escrow for taxes and insurance, stated-income and low-documentation lending, and failure to give adequate consideration to a borrower’s ability to repay.  Using our authority under the Truth in Lending Act (TILA), we expect that we will soon propose rules to curtail abuses in mortgage advertising and to ensure that consumers receive mortgage disclosures at a time when the information is likely to be the most useful to them.”

Hopefully, this latest rate cut move and the efforts to heal the wounded subprime mortgage market will begin the long process of stabilizing the economy.  Perhaps in a year we will have a clearer picture of what our economic outlook actually is.