Bernanke has warning for Wall Street

In a speech in New York, the Fed chairman said the central bank's big interest rate cut last month has helped but that the Fed can't 'insulate investors from risk.'

(Source: CNNMoney.com)

In a speech to the New York Economic Club Monday night, Federal Reserve Chairman Ben Bernanke said the central bank's rate cut in September has shown signs of success, but cautioned that lenders and investors must bear responsibility for financial decisions that caused the subprime mortgage meltdown.

"Although the Federal Reserve can seek to provide a more stable economic background that will benefit both investors and non-investors, the truth is that it can hardly insulate investors from risk, even if it wished to do so," Bernanke said, adding that "over the past few months...those who made bad investment decisions lost money."

The Fed slashed the federal funds rate, a key short-term interest rate that impacts rates on consumer loans, by a half of a percentage point on September 18. Bernanke said the rate cut, combined with an earlier cut to the symbolic discount rate in August, helped to "reduce some of the pressure in financial markets" and that "the improved functioning of financial markets is a positive development."

Behind the Citigroup rescue
Bernanke also said that the weakness in the housing market "is likely to be a significant drag on growth in the current quarter and through early next year."

But he hinted that it may not get that much worse and that investors and lenders may have learned from their mistakes. He did not specifically mention a plan unveiled Monday by a group of big banks to create a fund to buy mortgage-backed securities in his prepared remarks, however.

"Rather than becoming more crisis-prone, the financial system is likely to emerge from this episode healthier and more stable than before," he said.

Investors looking for a sign that the Fed may cut rates again at the conclusion of a two-day meeting on October 31 may be disappointed though. He indicated that the Fed "was prepared to reverse the policy easing if inflation pressures proved stronger than expected."

But during a question and answer session following his speech, David Malpass, chief economist at Bear Stearns, asked Bernanke if he thought the value of the dollar impacts inflation. Bernanke said he did not think a fixed exchange rate system affects the economy.

(aC: I will stick my neck out and state it here that I do not think the Fed will cut its rates any further at its coming Oct 31 meeting. Reason? The Dow is back to its all time high at the 14,000 level; There has been no news lately with regard to any financial institutions going bankrupt because of the sub-prime mortgage crisis; Consumer confidence is back judging from job data and Consumer Price Index.)