A Year Later, Fed Faces Growing Financial Storm

When Federal Reserve officials gathered for their annual Jackson Hole conference last August, Bear Stearns shares were trading at well over $100 apiece.

The benchmark federal funds rate was 5.25 percent, more than double where it stands now, and oil cost about $70 a barrel.

Twelve months later, Bear Stearns is gone, as is about $400 billion from banks' balance sheets. Legendary oilman T. Boone Pickens thinks the days of oil under $100 a barrel may be gone, too.

Looking back at the 2007 conference provides some cringe-inducing moments.

In his speech at the Wyoming mountain resort, Fed Chairman Ben Bernanke declared that the central bank was ready to act to shield the economy from the credit crisis but would not save investors who made bad choices.

"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 at the time, words that now sound ironic in light of the Fed's role in rescuing Bear Stearns from bankruptcy in March.

Now, Bernanke is hoping the Fed won't have to act again.

The conference, organized by the Federal Reserve Bank of Kansas City, typically draws leading economists and central bankers from around the world and aims to focus on the hot topics of the day.

Last year's theme, fittingly, was housing, housing finance, and monetary policy.

Much of the discussion and debate centered on hypothetical concerns about how hard the housing downturn might hit the economy.

Now that many of those dire predictions have come true, the focus has turned toward how to fix those problems.

Bernanke will kick off this year's conference with a speech Friday on "Financial Stability," a broad topic that could encompass anything from regulatory reform to international central bank cooperation.

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If his recent comments to Congress are any guide, the speech will likely have a heavy helping of uncertainty about when the housing market will finally recover from a bust that has dragged home prices down by 20 percent in some areas.

What has gone wrong for Bernanke and company in the past year is well documented.

The Fed was roundly criticized last August for being slow to recognize the magnitude of the housing crisis and its potential for wreaking havoc on the economy.

Luminaries such as Martin Feldstein, the long-time head of the National Bureau of Economic Research, chided the central bank last summer for not lowering interest rates quickly enough to counter the housing downdraft and stave off a recession.

Mary Altaffer / AP Federal Reserve Chairman Ben Bernanke.

In March, the collapse of Bear Stearns left the Fed open to tough questions about whether it was encouraging Wall Street's excesses by coming to the rescue, orchestrating the firesale of Bear Stearns to JPMorgan Chase.

Bernanke may find a more complimentary audience this year.

He has managed to defuse some of the criticism by finding creative ways besides lowering interest rates to ease credit constraints.

The Fed has launched a series of lending facilities that have helped to bolster confidence in debt-laden financial firms—and added a half-dozen new acronyms to the Wall Street lexicon.

The past month has brought some much-needed relief on the inflation front as oil prices came down from a July peak above $147 per barrel to trade below $115.

While that is still well above where it was a year ago, and inflation remains above the Fed's comfort level, it certainly takes some pressure off Bernanke to raise short-term interest rates.

The downtrodden U.S. dollar has also made a solid comeback in recent weeks, quieting speculation about currency market intervention.

Goldman Sachs economists declared Thursday that the dollar had bottomed, in part because of weakening economic trends in Europe and Japan that have made the U.S. currency look more attractive by comparison.

"The dollar lows are almost certainly behind us," currency strategist Thomas Stolper wrote in a note to clients.

"Too many underlying factors have started to work in favor of the dollar to dismiss the recent bounce as temporary." While cooling inflation is certainly a welcome development, Bernanke is in no position to tout a healthy economy.

Credit conditions continue to tighten, as evidenced by the Fed's own survey of loan officers, released last week.

"The bullish combination we are looking for would be for falling inflation to intersect with improving credit conditions. We are not there yet," said Michael Darda, chief economist at MKM Partners.