Bernanke: I underestimated housing problem

updated 4:01 p.m. ET Nov. 23, 2008

WASHINGTON - Federal Reserve Chairman Ben Bernanke acknowledges he was wrong in believing that there would be limited fallout to financial markets from risky mortgages that soured after the housing market's collapse.

"I and others were mistaken early on in saying that the subprime crisis would be contained," Bernanke said in an article in the Dec. 1 issue of The New Yorker magazine.

"The causal relationship between the housing problem and the broad financial system was very complex and difficult to predict," he said in the piece titled "Anatomy of a Meltdown."

Subprime mortgages made to people with tarnished credit or low incomes were especially hard hit once the housing boom went bust. Foreclosures spiked, and financial companies wracked up huge losses as these investments turned bad.

The mortgage meltdown started in the United States in the summer of 2007 and rapidly spread to other countries, as well as to other types of lending, affecting even more-creditworthy customers. The problems with risky, subprime mortgages touched off what many call the worst financial crisis to hit the world since the 1930s.

To protect the economy from damage and help ease Wall Street turmoil, Bernanke and his colleagues cut a key interest rate in September 2007 — the first reduction in four years. Some critics at the time thought the Fed should have acted sooner.

Now more than a year into the crisis, Bernanke has taken a flurry of unprecedented — and some controversial — steps to help bolster the banking system and to get banks to lend money more freely again.

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The Fed is providing short-term cash loans to banks, is letting financial companies swap shunned mortgage securities for super-safe Treasury securities and is buying mounds of short-term debt from a host of companies. It also expanded its emergency lending facilities to investment firms, provided financial backing in JPMorgan Chase & Co.'s buyout of Bear Stearns and threw a financial lifeline to insurer American International Group.

Critics worry the Fed's actions could put billions of taxpayers' dollars in jeopardy and encourage financial companies to take excessive risk on the belief that the Fed will bail them out.

The Fed halted its rate-cutting campaign in late June out of fears it would worsen inflation. But it was forced to do an about-face in early October as economic and financial conditions deteriorated sharply, lessening the threat of inflation. The Fed joined with other central banks on Oct. 8 to slash rates, the first coordinated action of its kind in the Fed's history. It lowered rates again on Oct. 29 and is expected to cut rates yet again on Dec. 16.

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