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Bernanke anticipates small bank failures linked to mortgages

Friday, February 29th 2008 - 21:00 UTC
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Fed chairman Ben Bernanke Fed chairman Ben Bernanke

Federal Reserve chairman Ben Bernanke said on Thursday that small US banks are likely to fail in the months ahead as the housing slump takes its toll. Bernanke also warned that the US is currently facing a more difficult situation than in the aftermath of the dotcom bust in 2001.

"There will probably be some bank failures" Bernanke told the Senate banking committee in his second day of biannual testimony to Congress. He described the banks at risk as "small and in many cases new banks that are heavily invested in real estate in localities where prices have fallen". However he did not anticipate any "serious problems" at any of the big banks, which played the most important role in the US financial system. House prices in the US fell in 2007 for the first time since the Great Depression and contraction worsened in Jan 2008. These problems have extended to banks that awarded mortgages in the midst of the housing boom and later sold them in stock markets. "Since August we're suffering a sustained process of credit disruption which is not yet over". The Fed reacted to the credit crunch by cutting interest rates 2.25 percentage point since last August. Bernanke said he expected inflation to moderate, providing oil and other commodity prices did not continue to increase. But he did admit the Federal Reserve would have to take "very seriously" any sign that inflation expectations were rising. Nevertheless higher energy and commodities prices are generating an "inflationary stress which complicates the Fed's attempts to respond" to the weakening economic situation. Markets are expecting a further half point cut in the basic interest rate when the Fed monetary committee meets again next March 18. Bernanke said there were "some similarities with the 2001 experience" – in so far as this downturn, like the previous one, was being driven by a sharp fall in asset prices; but also "important differences". The fall in house prices was creating a "much broader set of issues" than the slump in tech stocks did. Moreover, the US was in a weaker position to respond to the negative growth shock today than it was in 2001. "We do have greater inflationary pressure at this point than we had in 2001," he said, noting that oil was about $20 a barrel in 2001 and was about $100 a barrel now. The dollar, which was strong in 2001, was weak today. This weakness was contributing to the increase in the price of oil, Mr Bernanke said. However, the weak dollar had the benefit of stimulating exports. The Fed chairman said the US was also "in a less advantageous situation" fiscally today than in 2001. Mr Bernanke brushed aside concerns that the US could be facing a period of 1970s-style stagflation, saying: "I do not think we are anywhere near to the situation that prevailed in the 1970s." "There's a palpable feeling of uncertainty and even fear in the markets", said Senator Christopher Dodd president of the Banking Committee. "There seems to be a confidence crisis in the US economy from the rest of the world. The US dollar was at its lowest since 1973", added Senator Dodd.

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