Federal Reserve Chairman Ben Bernanke predicted Tuesday the economy will rebound from an anemic performance at the start of the year even if the housing slump continues.
Economic growth in the first three months of this year nearly stalled, logging just a 0.6% pace. It was the worst quarterly showing in more than four years.
However, Bernanke said he believes some of the forces that figured prominently in that poor performance--including a bloated trade deficit, cutbacks by businesses in inventory investment and weak federal defense spending--"seem likely to be at least partially reversed in the near term."
Bernanke made his comments via satellite to an international monetary conference in Cape Town, South Africa. In his talk, he stuck to the Fed's forecast that the economy in coming quarters will advance "at a moderate pace, close to or slightly below the economy's trend rate of expansion." A copy of his prepared remarks was made available in Washington.
Some economists put the economy's trend, or normal growth rate at around 3% to 3.25%.
Even with Bernanke's hopeful outlook, the Fed chief did make clear once again that the painful residential real-estate bust, which started last year, "appears likely to remain a drag on economic growth for somewhat longer than previously expected," he said.
Residential construction will likely remain "subdued for a time" until builders can pare down a backlog of unsold new homes, he noted.
Problems Haven't Spread
But, thus far, the problems in the housing market haven't spread through the broader economy in a significant way, Bernanke said. "We have not seen major spillovers from housing onto other sectors of the economy," he observed.
On the inflation front, Bernanke said that underlying inflation, which excludes food and energy prices, still remains "somewhat elevated" despite some improvements. Bernanke again clung to the Fed's forecast that underlying inflation seems likely to moderate gradually over time. Still, he said, there is a big risk to the economy is if this forecast doesn't materialize.
Besides talking about the economy, Bernanke also discussed the troubles plaguing both lenders and borrowers with high-risk "subprime" mortgages, which are made to people with spotty credit histories.
Foreclosures and delinquencies have spiked as rising interest rates and falling home prices made it difficult for some people to keep up with their payments.
Bernanke, as he said in a speech last month, predicted there will be further increases in delinquencies and foreclosures this year and next as interest rates on many subprime adjustable-rate loans will go up as they reset.
Some analysts estimate that nearly 2 million adjustable-rate mortgages will reset to higher rates this year and next.
Even with the expectation of more problems in this area, Bernanke repeated his belief that troubles in the subprime mortgage market are "unlikely to seriously spill over to the broader economy or the financial system."
Loose Lending Standards
Bernanke acknowledged that problems in the subprime market can be traced in part to loose standards, which in some cases allowed people to get mortgages with little documentation.
Facing criticism from Congress about lax regulation in the subprime arena, Bernanke again said the Fed will consider tougher rules to crack down on abusive practices and improve disclosure.
"In deciding, we must walk a fine line: We have an obligation to prevent fraud and abusive lending; at the same time, we must tread carefully so as not to suppress responsible lending or eliminate refunding opportunities for subprime borrowers," Bernanke said.
In fielding questions after his speech, Bernanke said that the currently benign risk environment in the global financial markets that has led to relatively low long-term term interest rates over the last several years probably won't last forever.
To global investors, Bernanke offered this advice: "Keep your head about you, so to speak" and make sure risk assessment systems are in good condition.
Bernanke also repeated his belief that heavy regulations are not needed to guide the hedge fund industry. Market forces, he said, are the best way to police potential problems.
"We believe the first line of defense in ensuring stability in the hedge fund sector is via market discipline," he said. Regulators, however, do need to keep close watch on hedge fund activities, he added.
Warsh Weighs In
Also Tuesday, Federal Reserve Governor Kevin Warsh said that financial regulators must stay on guard for investor overconfidence about risk as new financial products increase liquidity in financial markets.
"There is little doubt ... that liquidity in most financial markets is high today and that investors seem willing to take risks, even at today's market-prevailing prices," Warsh said in remarks to the European Economics and Financial Centre in London.
Warsh did not comment on the outlook for the economy or interest rates in his prepared comments, which were distributed in Washington.