Today, Federal Reserve Chairman Ben Bernanke testified before Congress and released his semi-annual Monetary Policy Report on the state of the economy. Here is an excerpt:

The principal cause of the economic slowdown was the collapse of the global credit boom and the ensuing financial crisis, which has affected asset values, credit conditions, and consumer and business confidence around the world.  The immediate trigger of the crisis was the end of housing booms in the United States and other countries and the associated problems in mortgage markets, notably the collapse of the U.S. subprime mortgage market.  Conditions in housing and mortgage markets have proved a serious drag on the broader economy both directly, through their impact on residential construction and related industries and on household wealth, and indirectly, through the effects of rising mortgage delinquencies on the health of financial institutions.  Recent data show that residential construction and sales continue to be very weak, house prices continue to fall, and foreclosure starts remain at very high levels.

The financial crisis intensified significantly in September and October.  In September, the Treasury and the Federal Housing Finance Agency placed the government-sponsored enterprises, Fannie Mae and Freddie Mac, into conservatorship, and Lehman Brothers Holdings filed for bankruptcy.  In the following weeks, several other large financial institutions failed, came to the brink of failure, or were acquired by competitors under distressed circumstances.  Losses at a prominent money market mutual fund prompted investors, who had traditionally considered money market mutual funds to be virtually risk-free, to withdraw large amounts from such funds.  The resulting outflows threatened the stability of short-term funding markets, particularly the commercial paper market, upon which corporations rely heavily for their short-term borrowing needs.  Concerns about potential losses also undermined confidence in wholesale bank funding markets, leading to further increases in bank borrowing costs and a tightening of credit availability from banks.

Bernanke set off a rally in the markets after he proclaimed that the recession will end in 2009 and the economy will recover in 2010:

If actions taken by the Administration, the Congress, and the Federal Reserve are successful in restoring some measure of financial stability–and only if that is the case, in my view–there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery.  If financial conditions improve, the economy will be increasingly supported by fiscal and monetary stimulus, the salutary effects of the steep decline in energy prices since last summer, and the better alignment of business inventories and final sales, as well as the increased availability of credit.    

Read the Full Report.

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