Banks Warned On Risky Loans

Jim Spess of Breinigsville, Pa., ties a piece of leather to the temporary memorial to United Flight 93 at sunrise in Shanksville, Pa., on Sept. 11, 2006, the fifth anniversary of the crash.
AP Photo/Gene J. Puskar
While Wall Street listened in for a hint of what the Federal Reserve may do next, Alan Greenspan Thursday focused on the safety and security of America's banks.

The Fed chairman, who since March has been making a series of speeches warning banks to be careful, said banks must be vigilant against fraud and risky lending practices.

"The lax standards, excesses and fraud present in the few recent bank failures show that even as most banks post record profits, the deposit insurance fund can still experience disproportionate losses from undisciplined institutions," Greenspan said in a speech to the National Association of Urban Bankers.

Last year, the Federal Deposit Insurance Corp. was hit by the largest losses from bank failures since the banking crisis of the early 1990s.

Fraud was said to have been a major factor in three of those collapses, two of which cost the FDIC's insurance funds an estimated $982 million.

Greenspan did note recent encouraging signs that banks are starting to be more cautious.

Greenspan's speech, broadcast to the bankers' conference in San Francisco, dealt with the banking industry and did not offers clues about what the central bank's next move might be on interest rates.

Investors usually pay breathless attention to the Fed Chairman’s comments, but with the policymaking arm of the Fed, the Federal Open Markets Committee, scheduled to meet again June 27 and 28, Wall Street is looking for a sign of what the Fed will do next.

All markets closed down Thursday. The Dow Jones Industrial Average dropped 211.43 to 10,323.92. The Nasdaq closed at 3,205.36—down 65.25. The S&P 500 slipped 17.53, to end the session at 1,381.52.

What is inflation?
Inflation is a rise in the general price level—in other words, the price of all goods and services.

The government measures inflation with the Consumer Price Index, which is a measure of the cost of a basket of goods that an average American might buy.

The causes of inflation are often mysterious.

Sometimes prices of goods go up because of higher demand, and wages follow; other times, wages go up first and business owners raise prices to cover the higher wages.

Inflation can have wide-ranging effects.

First, it makes business decisions and investments uncertain. If prices are changin, it's tricky for two firms to enter into a long-term contract. It's also difficult for people to plan for retirement, because they can’t be sure how much their money will buy.

Inflation hurts people on fixed-incomes because it means they can buy less. It tends to discourage saving and investment because when inflation hits, people rush to buy things before prices go up further.

Inflation also tends to benefit people who owe money and hurt people who lend it. As prices rise over the life of a loan, the money lent out loses value.

(Source: Federal Reserve Bank of Boston)size>

For the sixth time since last June, the Fed raised interest rates May 16, hoping to prevent inflation. Evidence on price levels is mixed, however, making the Fed’s next move unclear.

"See, there is a fine line," says CBS News contributor Brian Finnerty. "They don't want to topple the economy over into a recession. Greenspan wants to cool it off, not kill it."

Higher interest rates boost borrowing costs for businesses and consumers, thereby slowing down the economy.

The Federal Reserve has hiked interest rates because it fears roaring economic growth will fuel inflation, since a hot economy increases demand for workers and goods. That increase in demand drives up prices.

Three reports issued Thursday offered a mixed picture of the economy's future.

Confirming preliminary figures released last month, the Commerce Department reported the economy grew at a 5.4 percent annual rate for the first three quarters of 2000, fueled largely by personal spending. The figure was lower than the record 7.3 percent rate of growth in the fourth quarter of 1999.

Prices increased 3.2 percent in the first quarter, the Commerce Department found.

The Labor Department reported jobless claims for the week ending May 20 rose 6,000 over the previous week, to 284,000.

And the National Association of Realtors reported that sales of existing-homes dropped 6.2 percent in April, bringing the seasonally adjusted annual rate to 4.88 million units—down from a 5.20-million unit pace in March.

For the last week, the major stock indices have shuttled between positive and negative territory with stunning 100-point changes.

It's called a bottoming-out process, says Finnerty, and it is almost over.

He bases his optimism on the prospect of strong earnings for many companies and the previous six hikes in interest rates this year, which should be successful in slowing the red-hot economy.

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