Associated Press

Four months into the job and the honeymoon is over for Federal Reserve Chairman Ben Bernanke. The stock market is gyrating. Inflation is picking up. Economic growth is slowing down. It’s an unsettling picture for Alan Greenspan’s successor.

Bernanke has made clear that his biggest concern at the moment is making sure inflation does not spread through the economy. The main remedy is raising interest rates.

Yet that also is Bernanke’s dilemma: How high can raise rates go before they slow an economy that already is showing signs of lethargy?

‘In the eyes of many, Bernanke will truly earn his stripes as Greenspan’s successor if he can tame inflation and avoid a recession,’ said Greg McBride, senior financial analyst at Bankrate.com.

When Bernanke took over the Fed on Feb. 1, the economy was motoring ahead. Inflation, outside a burst in energy prices, was fairly well behaved. The Dow Jones industrials average was drifting upward, breaking the 11,000-mark in the middle of February; by early May, an all-time high was in reach.

Then the market skidded in early June, spooked by Bernanke’s tough talk on inflation and the specter of higher interest rates.

Bernanke is a respected economist who spent most of his professional life in academia. Greenspan was a seasoned economic consultant who gained near legendary status as the central bank’s chairman for 18 1/2 years and evolved into a cultural figure during his tenure.

Greenspan and his predecessor, Paul Volcker, also faced daunting challenges early on in their jobs at the Fed.

‘It seems to be the modus operandi for a new Fed chief. As soon as the new Fed chairman sits down in his chair, then the markets deal him a whole bunch of crazy things,’ said Richard Yamarone, economist at Argus Research.

After just two months at the helm, Greenspan confronted his first major crisis: The stock market dropped 508 points on Oct. 19, 1987. The biggest one-day loss since the Great Depression shocked financial markets at home and abroad.

Greenspan nimbly handled ‘Black Monday.’ He quickly reassured Wall Street that the Fed would supply all the credit necessary to keep the nation’s financial system functioning.

For investors, Greenspan’s calming public response helped bolster the markets’ faith in the new chairman and ease fears he would be a political hack because of his close ties to Washington’s establishment.

Behind closed doors, Greenspan was more frank.

‘I think we’re playing it on a day-to-day basis. And in a crisis environment,’ he said in an emergency conference call with his Fed colleagues one day after the crash. ‘I suspect we shouldn’t really focus on longer-term policy questions until we get beyond this immediate period of chaos.’

When Volcker took office in August 1979, he had to contend with crippling inflation in the double digits. For all of 1979, consumer prices spiked by 13.3 percent. The economy, meanwhile, was losing steam.

It was eight days into his tenure that Volcker fretted to bank colleagues at a private meeting about the ‘crisis of credibility’ the Fed faced with investors and the public.

He also worried that people would fear that inflation would only get worse. ‘We can’t ignore the psychological problem that we have at the moment,’ Volcker said. The Fed, he said, needed to earn the confidence of investors and the public. ‘We haven’t got a helluva lot of time,’ Volcker warned, worried about the economy slipping into recession.

Volcker is credited with eventually breaking the back of inflation by raising interest rates to levels unseen since the Civil War. But the strategy came with a price: two recessions in the early 1980s and the nation’s monthly unemployment rate topped 10 percent.

Stung by economic malaise, President Jimmy Carter lost his re-election bid to Republican Ronald Reagan.

Both Volcker and Greenspan, who saw inflation creeping up when he came to office, understood the importance of getting inflation under control.

Bernanke does, too.

In a surprisingly candid speech on June 5, Bernanke made clear that he would do all he could to tame inflation. Fed watchers say Bernanke’s tough words were intended to bolster his inflation-fighting image.

Rising inflation barometers, Bernanke said, ‘are unwelcome developments.’

Consumer prices for the first five months of this year are bounding ahead at a 5.2 percent annual rate, compared with the 3.4 percent increase for all of 2005.

Prices _ excluding food and energy _ are advancing at a 3.1 percent pace this year; it was 2.2 percent last year.

For Bernanke and his predecessors, it is not just the inflation numbers that are so crucial. So, too, is the inflation mind-set of investors, businesses and consumers. If they believe prices will keep climbing in the future, it can affect behavior.

For instance, if workers think inflation will be higher a year from now, they are more likely to push for pay raises now. If businesses think costs will rise in the future, they may be more inclined to increase prices.

‘The best way to prevent increases in energy and commodity prices from leading to persistently higher rates of inflation is by anchoring the public’s long-term inflation expectations,’ Bernanke said June 5. ‘Achieving this requires, first a strong commitment of policymakers to maintaining price stability … and second a consistent pattern of policy responses to emerging developments as needed to accomplish that objective.’

That means another bump in interest rates at the Fed’s next meeting, June 28-29, to 5.25 percent, economists predict. Further increases could be in store depending on how inflation and economic activity unfolds.

CHICAGO (MarketWatch) — Climbing interest rates and cooling speculative demand is putting pressure on the housing boom, but as long as jobs continue to be created and builders curb production, the sector will experience a soft landing, according to Harvard’s Joint Center for Housing Studies.

The center’s "State of the Nation’s Housing" report, released on Tuesday, predicted that even though home-price growth will fall to more moderate levels in many areas, sharp drops in prices are unlikely. The absence of severe overbuilding or big job losses in major metropolitan areas is an important factor in the stability, the report said.

About 1 million people became homeowners last year, and mortgages including low-down payment, hybrid-adjustable and interest-only loans helped them make the purchases amid higher home prices and interest rates, the report said. Most owners with adjustable loans have an initial fixed-rate period of three or more years, and most interest-only loans extend for at least five years.

"While homeowners with annually adjusting mortgage rates are facing interest increases this year, including those with expiring teaser discounts, only about one in 10 homeowners face higher mortgage payments this year" Nicolas P. Retsinas, director of Harvard’s Joint Center for Housing Studies, said in a news release. Years of high appreciation rates, however, are feeding housing affordability problems, the report found. Between 2001 and 2004, the number of households spending more than half their incomes on housing increased by 14% to 15.8 million. In addition, the bottom three-quarters of the income distribution is seeing slow wage growth that isn’t keeping pace with rising housing costs. The supply of rentals affordable on a $16,000 annual income fell by 1.2 million between 1993 and 2003.

 "Slow growth in domestic discretionary spending at the federal level and the reluctance of state and local governments to relieve intense barriers to the production of more affordable housing make the road ahead difficult," Retsinas said. "Unless governments step up to these challenges, spending on housing will increasingly crowd out spending on pensions and savings among those with low and moderate incomes."

The report also looks at the contribution foreign-born and minority owners will make to overall household growth. The center projects net immigration will run at 1.2 million annually, which will help drive household formation to 14.6 million over the next ten years. "Strong household growth, combined with record incomes and wealth, will lift housing investments to new highs next decade," Eric Belsky, executive director of center, said in the news release. "Each generation is achieving higher homeownership rates, incomes, and wealth than the one ahead of it, with the leading edge of the echo baby boom now in their 20s and the baby bust now in their 30s starting off on especially high paths. This is despite the fact that each younger generation has successively higher shares of foreign-born and minority household heads with lower average incomes than same-age native-born whites."

Other findings:

• A renewal of rental demand was seen in all four regions of the country last year. Rental vacancy rates fell from 10.2% to 9.9% in 2005.
  
• Adjustable rate mortgages shares fell from 35% in 2004 to 31% in 2005. Interest-only loans rose to 20% of loan originations in 2005.
• Subprime originations increased in real terms to $625 billion in 2005 from $210 billion in 2001; more than one in 10 mortgage holders is a subprime borrower.
  
• House prices increased 9.4% in 2005, after adjusting for inflation. Of the 149 largest metropolitan areas in the country, the number in which median house prices are at least four times the median household incomes increased from 13 in 2001 to 49 in 2005.
  
• Minorities accounted for 63% of household growth from 1995 to 2005. They are projected to account for 71% of household growth from 2005 to 2015, which would put the minority share of all households from 28% today to 33% in 2015.

The 10 most overvalued U.S. home markets
1. Naples, Fla.
2. Salinas, Calif.
3. Port St. Lucie, Fla.
4. Merced, Calif.
5. Bend, Ore.
6. Stockton, Calif.
7. Punta Gorda, Fla.
8. Santa Barbara, Calif.
9. Madera, Calif.
10. Riverside, San Bernardino, Calif.