Thank you, Mr. Chairman. I think President Stern framed it well in bringing focus to the effect on our thinking that the financial markets are having. As many have said, the central question is not whether the economy is softening but whether it is softening beyond the range that underpinned the policy decision in October. I’d add to that a range of questions related to financial markets, particularly the question of whether the deterioration in the financial markets changes the prospects for achieving financial stability, the potential for spreading to a wider array of financial markets and institutions, the potential for spillover to the general economy, and the compounding of the already heightened degree of uncertainty. All of these weigh heavily on my thinking. Like the Greenbook projections, Atlanta’s forecast has been revised down as a result of incoming data since the last meeting. I just point out, speaking only for ourselves, that these downward revisions of previous forecasts and our general outlook have been a pattern over recent months.
The current situation is extremely difficult to read—which is another way of saying that uncertainty around our forecast has increased yet again. Contributing to this uncertainty is the continuing, if not accelerating, gap between the anecdotal information and the views I’ve received from Wall Street versus Main Street. The expectations of financial market participants have deteriorated and can be characterized as extremely serious. However, the message I get from directors and representatives of nonfinancial businesses outside the housing sector, though relatively pessimistic, has not changed substantially since our October meeting. In my conversations with financial market contacts, to varying degrees I heard the persistent and growing apprehension concerning the spread of turmoil to an expanding set of affected markets and institutions and a wondering of what will be the next shoe to drop. One consistent message is the belief that the recent volatility and increase in term spreads cannot be entirely explained by the year-end problem. Most of my contacts agreed that year-end balance sheet concerns are adding to market stress, but no one expressed confidence that getting past year-end will bring much reduction of concerns over counterparty weakness, asset values, and secondary market liquidity. Most expect financial market turmoil to be protracted, with increasing risk to the general economy. Almost all my contacts noted that deteriorating housing values are a root cause, feeding problems in the markets. This view holds that the adjustment in prices and inventory required to stabilize the housing sector will take many months to play out, and until that occurs, the value of structured financial instruments and the solvency and liquidity of structured investment vehicles will be uncertain. There remains a great deal of skepticism that arrangements like the super SIV and the Treasury’s rate freeze plan will have much tangible effect. The issue of SIV restructuring and support by sponsors is a growing focus of concern because of their linkage to money market funds as well as their contribution to a general contraction of credit availability. In sum, my contacts in the financial industry uniformly express the belief that things will not get better any time soon and may well get worse. While recognizing that a rate reduction does not directly address the information problems in the markets, there is widespread sentiment that lower costs of funds will help.
Turning to the anecdotal inputs from contacts in my District, there is some divergence of views between contacts directly affected by the housing sector, including bankers, and others. Bank loan activity remains particularly weak in real estate segments. Trucking, large retailers, auto dealerships, and businesses supplying building materials and household durables were identified as segments where loan volumes are slipping. Industrial warehouse markets have weakened in some metro areas as subcontractors have exited. Bankers also expect that consumer credit exposures in credit cards, auto loans, prime mortgages, and HELOCs will see a combination of credit deterioration and demand contraction in 2008. The anecdotal messages from other contacts are less dire. We took great care in our information-gathering this round to probe hiring expectations, investment plans, and credit availability conditions. Though credit conditions do seem to have tightened, we still are not hearing that they are preventing planned spending. Spending and hiring plans remain on the weak side, but no more so than was the case at our October meeting. Consistent with the Greenbook projection for exports, we heard that spending from abroad, including international tourism and condo-purchase activity, continues relatively strong. At the branch board meeting in Miami, I heard that Russians are the latest foreign buyers of condos. So combine that with President Poole’s comment on trucks, as a child of the Cold War, I think it is very ironic that our bailout is coming from the Russians. [Laughter] On the employment front, the demand for workers in sectors such as hospitality and energy remains quite strong, but overall plans appear to be more cautious. The trend in regional labor data mirrors the slowing trend in the national statistics.
Each FOMC round my staff provides a summary sentiment index of expected economic conditions over the next six months based on responses of directors and contacts. Relative to the October meeting, that index is little changed, with the majority expecting flat or slower growth. When I combine the somewhat, but not dramatically, worse data inputs since the last meeting with the anecdotal and survey information from regional and other markets, I’m left with a view that economic fundamentals, current and prospective, have not yet fallen off a cliff. That being said, there’s not much of a case to be made for any risk assessment other than one weighted to the downside. In my view, the potential for protracted and growing financial market troubles should weigh heavily in the policy decision, and though recent core inflation readings are acceptable, I continue to be concerned about the ongoing divergence between headline and core inflation. Until they converge, price pressures cannot be removed from the watch list. But overall I see more uncertainty and, therefore, more downside risk in the real economic growth picture. Thank you, Mr. Chairman.