ben s bernanke : the economy and financial markets testimony of mr ben s bernanke, chairman of the board of governors of the us federal reserve system, before the committee on banking, housing, and urban affairs, us senate, washington dc, 14 february 2008. * * * chairman dodd, senator shelby, and other members of the committee, i am pleased to be here to offer my views on financial conditions, the near - term economic outlook, and related issues. as you know, financial markets in the united states and in a number of other industrialized countries have been under considerable strain since late last summer. heightened investor concerns about the credit quality of mortgages, especially subprime mortgages with adjustable interest rates, triggered the financial turmoil. however, other factors, including a broader retrenchment in the willingness of investors to bear risk, difficulties in valuing complex or illiquid financial products, uncertainties about the exposures of major financial institutions to credit losses, and concerns about the weaker outlook for the economy, have also roiled the financial markets in recent months. as the concerns of investors increased, money center banks and other large financial institutions have come under significant pressure to take onto their own balance sheets the assets of some of the off - balance - sheet investment vehicles that they had sponsored. bank balance sheets have swollen further as a consequence of the sharp reduction in investor willingness to buy securitized credits, which has forced banks to retain a substantially higher share of previously committed and new loans in their own portfolios. banks have also reported large losses, reflecting marked declines in the market prices of mortgages and other assets that they hold. recently, deterioration in the financial condition of some bond insurers has led some commercial and investment banks to take further markdowns and has added to strains in the financial markets. the banking system has been highly profitable in recent years and entered this episode with strong capital positions. some institutions have responded to their recent losses by raising additional capital. notwithstanding these positive factors, the unexpected losses and the increased pressure on their balance sheets have prompted banks to become protective of their liquidity and balance sheet capacity and, thus, to become less willing to provide funding to other market participants, including other banks. banks have also become more restrictive in their lending to firms and households. for example, in the latest senior loan officer opinion survey conducted by the federal reserve, banks reported having further tightened their lending standards and terms for a broad range of loan types

over the past three months. more - expensive and less - available credit seems likely to continue to be a source of restraint on economic growth. in part as the result of the developments in financial markets, the outlook for the economy has worsened in recent months, and the downside risks to growth have increased. to date, the largest economic effects of the financial turmoil appear to have been on the housing market, which, as you know, has deteriorated significantly over the past two years or so. the virtual shutdown of the subprime mortgage market and a widening of spreads on jumbo mortgage loans have further reduced the demand for housing, while foreclosures are adding to the already - elevated inventory of unsold homes. further cuts in homebuilding and in related activities are likely. conditions in the labor market have also softened. payroll employment, after increasing about 95, 000 per month on average in the fourth quarter, declined by an estimated 17, 000 jobs in january. employment in the construction and manufacturing sectors has continued to fall, while the pace of job gains in the services industries has slowed. the softer labor market, together with factors including higher energy prices, lower equity prices, and declining home values, seem likely to weigh on consumer spending in the near term. on the other hand, growth in u. s. exports should continue to provide some offset to the softening in domestic demand, and the recently approved fiscal package should help to support household and business spending during the second half of this year and into the first part of next year. on the inflation front, a key development over the past year has been the steep run - up in the price of oil. last year, food prices also increased exceptionally rapidly by recent standards, and the foreign exchange value of the dollar weakened. all told, over the four quarters of 2007, the price index for personal consumption expenditures ( pce ) increased 3. 4 percent, up from 1. 9 percent during 2006. excluding the prices of food and energy, pce price inflation ran at a 2. 1 percent rate in 2007, down a bit from 2006. to date, inflation expectations appear to have remained reasonably well anchored, but any tendency of inflation expectations to become unmoored or for the fed's inflation - fighting credibility to be eroded could greatly complicate the task of sustaining price stability and reduce the central bank's policy flexibility to counter shortfalls in growth in the future. accordingly, in the months ahead we will be