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Fed chief fails to calm jittery stock markets

Times Staff Writers

Federal Reserve Chairman Ben S. Bernanke failed Thursday either to calm pessimists’ fears or to raise optimists’ hopes about the economy -- leading to the second straight day of losses on Wall Street.

In lengthy congressional testimony, Bernanke tried to deliver a balanced message. On the downside, he said, the Fed believes that the economy will slow significantly by the end of the year and that problems in the housing market have yet to bottom out.

But the housing market’s misery shouldn’t derail the economy overall, he said.

“The broader market outside of housing has been remarkably resilient over the last couple of years,” Bernanke said in response to questions from Congress’ Joint Economic Committee. “So far, at least, the spillovers of housing to the broader economy [have] been limited.

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“Our forecast is for moderate but positive growth going forward,” Bernanke said.

But his caution, combined with a disappointing earnings forecast from computer-networking giant Cisco Systems Inc. and tepid retail sales, sent Wall Street into a tailspin for most of the day.

Investors said they weren’t troubled so much by what Bernanke said as by the perception that the Fed is pinned in a corner and can’t do much to ease the mortgage crisis and resulting credit crunch.

“Bernanke is in a spot, and he’s trying to provide some comfort to the market by saying, ‘We don’t know what the immediate future holds but we’ll remain vigilant and if action needs to be taken we’ll take it,’ ” said Stanley Nabi, chief strategist at New York-based Silvercrest Asset Management in New York. “There’s nothing else he can say.”

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Martin Regalia, chief economist with the U.S. Chamber of Commerce, said there was a disconnect between what the numbers were telling Bernanke in Washington and what investors were reacting to on Wall Street. The Fed’s job is to set monetary policy to keep inflation under control and the economy growing steadily, Regalia said, not to reassure investors who made risky decisions.

“You can’t fault Mr. Bernanke or Fed policy. They are doing a very credible job of balancing all the issues,” Regalia said. “What’s spooking Wall Street is that they for quite a while totally mispriced risk. We see everybody blaming everybody else.”

Bernanke’s three hours on Capitol Hill were the first time he fielded questions from lawmakers since the central bank cut interest rates last week in an effort to stave off recession and keep credit markets liquid amid the mortgage meltdown.

The crisis -- triggered in part by rising defaults from borrowers who cannot afford higher payments on adjustable-rate mortgages -- is also hurting home prices by putting more foreclosed properties into an already weak market.

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What unnerves Wall Street is that no one knows how many more loans will go into default, and who will pick up the tab.

Since September, the Fed has lowered its benchmark rate to 4.5% from 5.25%.

Bernanke repeated last week’s message: that even though markets are still struggling to assess the damage from mortgage defaults, the Fed is not inclined to lower interest rates further because high oil prices and a weak dollar make inflation more likely in the months ahead.

“There are a lot of uncertainties,” Bernanke said. “The financial market turmoil creates a good deal of uncertainty . . . and the housing market creates uncertainty. The dollar and oil prices are sources of uncertainty.

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“Our view is that we have a mandate to fulfill, and that mandate is to ensure price stability and maximum employment,” Bernanke added. “As we see those risks change in one direction or another, we certainly want to be able to respond as needed to meet our mandate.”

Bernanke said that in particular, the Fed was watching the recent drop in the value of the dollar on international markets.

“The decline in the dollar has the potential to raise import prices and contribute to inflation. Therefore, we are very attentive to that risk,” he said.

Joel Naroff, president of Naroff Economic Advisors, a forecasting firm in Holland, Pa., said that in effect, the Fed’s two mandates -- to curb inflation and foster economic growth -- are in conflict at the moment.

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“This is why the Fed chairman makes the big bucks,” Naroff said. “It’s easy to make a decision when the economy is soft or when inflation is rising, but when you have these two opposing forces at work, it’s very, very hard.”

Investors have been caught flat-footed in the last two weeks by huge mortgage-related losses at Wall Street’s premier investment banks and fear that more losses will follow.

But many believe that even if the Fed were to slash rates further, it would do little to prop up existing sub-prime-related securities that are skidding in value.

“The Fed is irrelevant here,” said Michael Metz, chief investment strategist at Oppenheimer Holdings in New York. “It’s not the cost of short-term funds. It’s a question of the value of the collateral behind the debt held by financial” institutions.

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The drop in the dollar complicates things for policymakers. The weak dollar has helped spur U.S. exports and gross domestic product growth in recent months. But American financial uncertainty is prompting many to dump U.S. stocks and bonds in favor of those in other countries, which exacerbates the market downturn by exerting further pressure on U.S. assets.

“The main problem now with the U.S. dollar is related to confidence in the U.S. financial system,” said Brian Bethune, director of financial economics for Global Insight Inc. in Waltham, Mass. “When you have large banks and investment houses reporting large losses, that creates some concern among overseas investors about the stability of the U.S. financial system.”

Consumer spending, the main driver of the economy, is also a question mark.

Economists have predicted that consumer spending would slow as the year drew to a close, and October numbers released Thursday by retailers bolstered that forecast. Sales at stores open a year or more rose just 1.6%, compared with a 3% gain in the same month last year, according to the International Council of Shopping Centers’ tally of 44 chains nationwide.

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In more dreary news for companies banking on a happy holiday season, retailers recorded their flimsiest October sales gains in 12 years as most big chains failed to meet Wall Street’s expectations.

Weather played a role because warm temperatures squelched demand for seasonal merchandise.

But it was also a sign that consumer spending might be slowing, ensuring a Scrooge-like holiday season for retailers.

It was another down day on Wall Street, after a 361-point drop on the Dow Jones industrial average a day earlier.

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The Dow average recovered most of a 220-point loss Thursday but still fell 33.73 points, or 0.3%, to 13,266.29.

The sharpest decline came in the technology-laden Nasdaq composite index, which slumped 52.76 points, or 1.9%, to 2,696.00.

Tech stocks had been one of the market’s few remaining bright spots until Thursday.

Investors recently have loaded up on companies such as Google Inc. and Apple Inc. for their strong earnings and perceived immunity to housing-related problems.

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Cisco reported big quarterly profits late Wednesday, but investors were unnerved that the company did not forecast an even rosier outlook for the rest of the year. Investors took that as the first whiff of trouble in technology and sent Cisco’s shares down 9.5%. Google was off 5.3% and Apple fell 5.8%.

Financial stocks, which have been pummeled in the last week, led the afternoon rally. Morgan Stanley, an investment bank that reported a $3.7-billion sub-prime-related hit late Wednesday, rose 4.9%.

The Fed will meet to assess interest rates Dec. 11, a stretch that Naroff said would seem like a “long, long time” to investors.

“The next month could be an eternity,” he said, noting that only a few financial institutions had announced their sub-prime losses and more were expected.

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maura.reynolds@latimes.com

walter.hamiliton@latimes.com

Reynolds reported from Washington and Hamilton reported from New York. Times staff writer Leslie Earnest in Orange County contributed.

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