Bernanke says gale force financial storm is still blowing

The credit crisis has created the most challenging economic and monetary policy environment in recent memory, the chairman of the US Federal Reserve has admitted.

Ben Bernanke presented a downbeat assessment of the economic effects of the unfolding crisis when he addressed the US central bank's annual symposium in Jackson Hole, Wyoming, yesterday.

And he warned Wall Street not to expect the Fed to continually come to its rescue, as it had to when the investment bank Bear Stearns teetered on the brink of collapse in March. Mr Bernanke called for sweeping new powers for the Fed to counter risks to the financial system, plus new regulations to tame the world of derivatives trading, whose opacity has contributed to a climate of fear and uncertainty since the credit crisis exploded a little over a year ago.

At the 2007 symposium, the Fed had still to respond to the crisis by cutting interest rates, much to Wall Street's chagrin, and Mr Bernanke said then that the US economy was still growing strongly, even if the risks were rising.

Yesterday, after a year in which the markets failed to stabilise, he took a markedly different tone. "Although we have seen improved functioning in some markets, the financial storm that reached gale force some weeks before our last meeting here in Jackson Hole has not yet subsided, and its effects on the broader economy are becoming apparent in the form of softening economic activity and rising unemployment. Add to this mix a jump in inflation, in part the product of a global commodity boom, and the result has been one of the most challenging economic and policy environments in memory."

The Fed chairman's speech was interpreted as showing that its Federal Open Market Committee has little inclination to raise interest rates any time soon. Mr Bernanke sounded more confident than ever that current high rates of inflation will subside, thanks to recent falls in commodities prices and a rebound by the dollar. "If not reversed, these developments, together with a pace of growth that is likely to fall short of potential for a time, should lead inflation to moderate later this year and next," he said.

The speech on reducing system risks to global finance tackled the legacy of the Bear Stearns bail-out, when the Fed engineered its firesale to JPMorgan Chase, but only by promising it would act as a lender of last resort to investment banks for the foreseeable future. Mr Bernanke added his weight to calls for a "liquidator of last resort", a body which would be able to organise an orderly wind-up of financial firms so enmeshed in the global markets that they must not be allowed to go suddenly bankrupt.

Bear Stearns shareholders lost most of their investment in the bail-out, but bondholders survived intact, a situation Mr Bernanke suggested could lead to "moral hazard", if bondholders become cavalier with regards to risk, believing the Fed will rescue them.