The Fed chairman, who is scheduled to speak in Jackson Hole, Wyo., before the annual Federal Reserve conference, faces a challenging job steering the economy through rough waters at a critical point in the U.S. recovery amid doubts about his leadership as a crisis manager.
A worried financial market is virtually demanding an interest-rate reduction Sept. 18, when the Fed next meets, and perhaps two or three after that, to soothe a roiling stock market and prevent a possible recession. Many analysts said Bernanke, normally a cautious, low-key person, should act swiftly and boldly to establish his credentials more firmly.
But lowering rates brings dangers of its own, potentially kindling inflation and sending an unintended message that the Fed is willing to bail out investors who have lost money in the market turmoil.
That is only half the problem. According to analysts, Bernanke must also provide assurances that the Fed is on top of a credit problem that has spread beyond the highly risky subprime mortgage market and could cause severe disruption in financial markets.
"The Fed is between a rock and a hard place," said Brian Wesbury, an economist at First Trust Advisors, in Lisle, Ill. "He's going to have to walk a fine line."
This is a big moment for Bernanke, who uses the cautious, measured language of other Fed chiefs but who also is going to be in the spotlight. He replaced Alan Greenspan as Fed chief only a year and a half ago. His critics accuse him of acting too slowly, saying that Greenspan would have moved long ago. Analysts see him as more self-effacing and a leader who believes in building up the institution, not the personality.
Bernanke has signaled that he stands ready to act to help prevent a severe blow to the economy, but there is doubt about how far he is willing to go and what the best move would be. Wesbury, for example, would prefer that the central bank stand pat, saying the economy can weather the storm and that this would help the country to move past the mortgage crisis sooner. But others say the Fed should cut interest rates sharply over the next several months.
If Bernanke does not reduce interest rates next month, there would be "severe disappointment" in financial markets and a steep decline, said Joel Naroff, a Holland, Pa., economic consultant. He favors rate cuts totaling 1.5 to 2 percentage points over the next six months. Others said a smaller decrease would do.
"There is a strong belief that the Fed has misjudged the situation," Naroff said. "Now we have got to see if the Fed is on top of the situation."
To make matters dicier, Diane Swonk, an economist at Mesirow Financial in Chicago, said Bernanke and the Fed will not have sufficient economic data on which to make a judgment on Sept. 18, so they will have to make a gut-level call on the economy's course.
But this is an unusual moment, she and others said, since an apparent "confidence crisis" has seized both borrowers and lenders at many levels beyond the mortgage market.
Swonk said this is because lenders can't be absolutely sure that the firms or institutions borrowing the money don't have some exposure to bad mortgage debt on their books. So, she said, one of Bernanke's chores will be to restore confidence to the credit markets by trimming interest rates.
One of the problems is that no one knows the extent of the subprime mortgage problem, since mortgages are routinely pooled and sold as securities to many investors. Those who hold these mortgage-backed securities are not eager to say they have them in their portfolio.
"No one wants to 'fess up,'" said Barry Bosworth, an economist at the Brookings Institution, a Washington think tank.
One thing for sure is that mortgages, particularly the large "jumbo" mortgages, are harder to get and that mortgage applicants have to be well-qualified financially. Housing prices are down in many markets across the country.
The U.S. economy was strong in the second quarter, rising at an annual rate of 4 percent, according to revised figures announced yesterday by the Commerce Department. But the growing credit crunch since then has made the third-quarter outlook bleaker. Slower growth is in the offing for at least the next two quarters, said John Silvia, chief economist at Wachovia Bank.
William Neikirk writes for the Chicago Tribune.