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Fed's Kroszner Says Mortgage Crisis Could Hit Economy

Turmoil stemming from subprime mortgage delinquencies could dampen demand for homes and ultimately slow economic growth, Federal Reserve Governor Randall Kroszner said Thursday.

But the financial turbulence comes as U.S. commercial banks are strongly capitalized after years of robust profits, Kroszner said in a speech to a conference on the Asian financial crises in the 1990s that was organized by the San Francisco Fed.

"We continue to follow these developments in financial markets closely, particularly those that may have a broad impact on real economic activity," said Kroszner, who spoke by video link.

Financial stress has not been limited to mortgage markets, but it has spread, he said, adding that investors are wary about risk and nervous about the underlying assets of securities.

"In general, a shift in risk attitudes has interacted with heightened concerns about credit risks and uncertainty about how to evaluate those risks," Kroszner said.

A crisis in credit markets, triggered by a jump in delinquencies among adjustable rate subprime mortgages, shows that some investors failed to exercise adequate due diligence about the securities they were buying, the Fed governor said in response to questions after his speech.

Kroszner, cautioning that his remarks were intended to be a survey of academic research rather than a commentary on the current financial situaiton, said crises in the banking sector can lead to disruptions in the real economy.

"A healthy banking system generally contributes to strong economic growth, and banking crises can present a substantial drag on the real economy," he said.

Kroszner's remarks come after Fed Chairman Ben Bernanke said the U.S. central bank would ready to act as needed to limit damage to the economy from fallout from market turbulence, which has had repercussions for firms and investors around the world.

Bernanke said the Fed would carefully monitor fresh data and anecdotal evidence of what if any impact tighter credit and market volatility was having on broader economic performance.

Meanwhile, Kroszner said that banking crises affect those firms that are most dependant on external sources of finance -- rather than cash flow -- to finance their growth. Research shows greater impact of banking crises on sectors of the economy where there are many new firms who depend on external sources of finance, he said.

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