I took the liberty of condensing the speech…

The Sources of Financial Turmoil: US Housing Boom,  Credit Boom and Growth in Emerging market economies. The Credit Boom is where lenders and investors aggressively sought out opportunities to take credit risks even as market risk premiums contracted. This led to “risk taking and reaching for yield” by some financial institutions. Regulations by the fed issued new guidance on the nontraditional mortgage lenders and on commercial real estate lending.  Now, more demanding standards for the measure and management of risk is required.

The housing boom ended as rising housing costs made housing even less affordable. A basic premise of many adjustable and subprime loans was that home appreciation would generate enough equity to permit a refinance in the future to avoid the fully inedexed rate. As that concept proved false, Investors (global investors) retreated from the mortgage related securities. Thus was the end of the Credit Boom. Naturally, the credit ratings for mortgage backed securities were downgraded, investors exercised more caution and reversed their aggressive risk taking investments. Large financial institutions reportedly lost $300 Billion in credit losses. Thankfully, most of these financial institutions maintained strong capital positions and are able to weather the storm. On a global scale, higher commodity prices (namely oil) are governed by market supply and demand- unfortunately the U.S. is a very hungry consumer of oil.

The Outlook: Credit parameters are restrictive in residential and commercial real estate.  Residential construction continues to contract and unsold homes continue to increase in numbers. Consumer spending is holding better than expected, but more challenges remain as house prices continue to fall, job markets soften, credit requirements get tighter, energy prices increase and consumer sentiment declines. Business face weaker demand, however, the foreign demand for US goods has provided some offset.  Economic growth is slow, better economic conditions expected in the second half of 2008.

The Fed’s response; First, support the return of financial markets to more normal functioning. Easing monetary policy substantially to stall further adverse effects on the economy. Work with the Treasury to monitor the value of the dollar overseas which contributes to rise in import prices and consumer price inflation. Secondly, improve market liquidity by reducing funding pressures thus increasing confidence of foreign investors. Also, deploying central bank liquidity where needed.

Last, acting as regulators. New rules to improve disclosure and ban deceptive practices in mortgage lending. Expect changes in stricter capital and liquidity rules, greater disclosure requirements and an emphasis on management of risk. The goal is to emerge with a financial system that is more stable without compromising innovation.

Please click here  Chairman Bernanke’s Remarks on the Economic Outlook for the full content.

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