US Economy Is 'Deeply Worrisome': Fed's Yellen

Recent trends in the U.S. economy are "deeply worrisome" at a time damage from the credit crunch has outpaced the Federal Reserve's huge interest rate cuts, a top Fed policy-maker said Thursday.

CNBC.com Janet L. Yellen

Janet Yellen, president of the San Francisco Fed, was the first Fed official to speak after Thursday's news that the U.S. economy contracted in the third quarter, and she suggested the worst was yet to come.

"For the fourth quarter, it appears likely that the economy is contracting significantly," Yellen told a University of California housing symposium in Berkeley, California.

"The mortgage meltdown is far from over (and) the economy and financial markets are still reeling from it." Most private-sector borrowing rates are higher now than at the start of the financial crisis in August 2007, despite "some of the most momentous steps in decades" from the Fed, she noted.

"I don't mean to imply that the rate cuts did no good; borrowing rates in my view would be substantially higher absent the reduction in our base lending rate," said Yellen, who is not a voting member of the Federal Open Market Committee in 2008 but will vote in 2009.

The FOMC on Wednesday voted to cut the benchmark federal funds rate by a half percentage point to 1.00 percent.

The Fed has cut rates 4.25 percentage points since September 2007.

Yellen did not specifically address the need for additional Fed rate cuts.

Financial markets point to another cut at the December FOMC meeting, to 0.75 percent.

Vicious Cycle in Full Swing

Yellen has warned for months about a vicious cycle between reduced credit availability, weakened financial institutions and the broader economy, and said that "adverse feedback loop" is now in full swing.

"A greatly reduced flow of credit in the economy ... is the major factor responsible for the economic downturn that now is under way," she said.

(Fed's Yellen says the economy is likely "contracting significantly" in Q4. Watch the accompanying video for more...)

For consumers, though, the credit problem is just one of "several negative factors" now at work, including a 9-month streak of lower monthly payroll employment, flat personal incomes and lower stock markets and housing values.

The Fed's steps to support credit markets are "extremely constructive" and will thaw credit flows over time, she said, citing "very tentative signs of an easing of stress in money markets." But with a long way to go before the credit crunch is totally alleviated, other types of policies, including programs that give direct assistance to homeowners to stem the flow of foreclosures, are worth pursuing, Yellen said.

"The bottom is not yet in sight" for falling house prices or housing starts, she said.

"By mitigating foreclosure sales at fire-sale prices, these programs may also support housing prices more generally and serve to limit the credit losses that have done so much damage to the financial system," she said.

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