ST. LOUIS — St. Louis Federal Reserve Bank president William Poole yesterday said the Federal Open Market Committee is “watching both recession and inflation risks.”

But he said it is “too early to tell” whether the economy will go into recession, the risks of which he said stem from “financial turmoil.”

In remarks prepared for delivery to the Financial Planning Association of Missouri and Southern Illinois, Poole said the turmoil “will take awhile” to play out, but nonetheless said he anticipated “a year of rising growth.”

The economy’s fundamentals are “strong,” he said.

Poole devoted the rest of his comments to five mistakes, which he said investors, borrowers, and financial institutions had made in the subprime mortgage crisis,and from which he said all need to learn.

“Our nation has enjoyed a long expansion and inflation has been relatively low,” Poole said. “However, since last August financial markets have been in considerable turmoil resulting from subprime mortgage lending and a deflating housing boom.”

Poole said the FOMC “is watching both recession and inflation risks” that “are primarily a consequence of financial turmoil, which has threatened to spread housing industry woes to the broader economy.”

“Will housing sector problems push the economy into recession?” he asked. “It is too early to tell right now, but what we can do is to examine the current situation closely and try to learn from it.”

“The current financial turmoil will take awhile to play itself out,” Poole said. “The fundamentals of our economy remain strong, however, and 2008 looks to be a year of rising growth.”

He noted that economic forecasters expect “slow expansion in the first half of the year and a quickening pace in the second half.”

Meanwhile, he said, borrowers, lenders and investors should “refocus on financial basics and reemphasize critical lessons about credit and risk.”

Poole identified “five major mistakes” that created the subprime mess: “too many borrowers took on mortgages they could not afford”; “mortgage brokers put too many borrowers into unsuitable mortgages”; “investment banks jeopardized their reputations by securitizing these mortgages when the underlying loans were backed by inadequate or spurious information”; “rating agencies that placed triple-A ratings on many securities backed by subprime mortgages”; and “investors who bought those securities without conducting an adequate analysis of the underlying investments. Investors too readily accepted the triple-A ratings at face value.”

In the question-and-answer session, Poole said wage pressures are well-contained and despite the jump in the unemployment rate in December, it still means the U.S. economy is in the “neighborhood” of full employment.

He added that the risk of recession has increased, but the risk of inflation is not absent.

Poole said he doesn’t believe the economy slipping into recession would damage the Fed’s credibility.

— Market News International

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