Bernanke: Fed Will Act If Needed But No Bailout

Dennis Cook / AP Federal Reserve Board Chairman Ben Bernanke.

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 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.

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% at its next policy meeting, on Sept. 18, if not before.

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 comments come as financial markets reel 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.

He 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.

President Bush, meanwhile, outlined steps to help struggling subprime mortgage borrowers. Bush, speaking at the White House an hour after Bernanke, offered assistance for homeowners with subprime mortgages to avoid default via changes to the tax code.

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

However, he noted the ground had since been shifted by 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 put particularly close attention to the timeliest indicators, as well as information gleaned from our business and banking contacts," he said.

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