By Sinead Cruise

LONDON, Aug 30 (Reuters) - Morgan Stanley (MS.N: Quote, Profile, Research) has completed the UK’s first residential property derivative trade with an embedded exotic option, the company told Reuters on Thursday.

Morgan Stanley and an undisclosed counterparty have agreed an exotic swap based on the Halifax House Price Index, the UK’s definitive index for trading movements in UK house prices, Morgan Stanley told Reuters.

Under terms of the groundbreaking deal, the counterparty gains if the Index rises, subject to a maximum payout but his capital is protected unless the Index falls beyond an initially specified point.

This type of exotic contract includes a “knock-in put” option and Morgan Stanley said this is the first property derivative trade to include the component.

The pricing of the deal and length of contract remains confidential but Guy Ratcliffe, who joined Morgan Stanley to spearhead its growing real estate derivatives operations in July, told Reuters the deal was worth more than 1 million pounds ($2.01 million).

“We have always enjoyed a leading presence in the direct property market but this deal illustrates our ambition to expand into the exotic derivatives market,” said Ratcliffe.

“It shows we are willing to do more than just the typical vanilla contract”, he said.

Morgan Stanley hopes the deal, which comes amid turmoil in global debt markets and a weakening in the fundamentals supporting direct investment in the physical asset class, will breathe life into the nascent derivatives market.

“Demand for these products is growing. This deal is tailored to cater for customers with a specific risk profile and these trades could become a larger feature of the retail investment market in the future,” Ratcliffe said.  Continued…

http://www.reuters.com/article/fundsFundsNews/idUSL3092685020070830

Bankers try to piece together subprime puzzle
Financial Times - 2 hours ago
By Eoin Callan and Krishna Guha Ben Bernanke, Jean Claude Trichet and other leading central bankers gather on Thursday in a lodge in the heart of Wyoming’s Grand Teton national park for the Federal Reserve’s annual Jackson Hole symposium.
Bernanke May Hear Call for Fed Activism on Regulation (Update1) Bloomberg
Wall Street All Ears for Fed Chief’s Big Speech Washington Post
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China’s savers are poised to go global

By Andrew Wood in Hong Kong

Published: August 28 2007 03:00 | Last updated: August 28 2007 03:00

A wave of private savings of up to $1,300bn could flow out of China into global bond and equity markets once individual Chinese investors gain more freedom to invest offshore, according to Capital Economics, a consultancy in London.

Last week, Beijing relaxed rules to allow mainland investors to buy shares directly on the Hong Kong stock market. Since then, the city’s benchmark Hang Seng index has powered ahead to erase all of last month’s losses from the global credit turmoil. Yesterday, it rose 2.9 per cent while a number of stocks trading at wide discounts to their mainland counterparts reached record highs on expectations of heavy buying by mainland investors.

Many analysts expect full liberalisation of rules on mainland investment.

Capital Economics said most of the $2,300bn of estimated savings in China was held in low-yielding bank accounts.

Demand for equities was strong, but the supply was limited to two mainland markets that looked increasingly overheated - Shenzhen has risen 160 per cent since the start of the year and Shanghai is up 92 per cent.

“The authorities are struggling to prevent hot capital from entering the country,” said Mark Williams, Capital Economics’ China analyst in the consultancy’s weekly newsletter.

“By encouraging outflows, they hope to ease some of the pressure on the central bank and domestic asset markets.”

Some western governments are believed to be uneasy about China’s state investment company’s recent high-profile purchases of big stakes in foreign companies such as Blackstone and Barclays. “A sustained outflow of funds from private investors would allow the Chinese state to take a step out of the limelight,” said Mr Williams.

Chinese investors, excluding the central bank, hold foreign securities worth5 per cent of annual economic output.

Mr Williams said China would generate $1,300bn of additional overseas investment if the country raised its level of foreign portfolio investment to the average for member countries of the Organisation for Economic Co-operation and Development.

“Of course, this will not happen immediately,” Mr Williams said.

“It took Japan 20 years from the opening of its capital account in the 1980s for its foreign portfolio holdings to rise from 5 per cent to 40 per cent of gross domestic product.”

Copyright The Financial Times Limited 2007

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New Bank Capital Requirements
Helped to Spread Credit Woes
August 30, 2007; Page A2

Even before the current financial firestorm passes, the search for people and institutions to blame has begun: Greed and hubris overtook common sense and propriety. Excessively easy credit overwhelmed good judgment and fueled a housing bubble. Profit-grubbing crooks took advantage of unsophisticated home buyers. Rating services blew it. Government overseers couldn’t keep up with financial innovation. U.S. regulators let shady subprime lenders slip through cracks in archaic rules. European bank regulators were blind.

The right answer will prove to be some combination of the above. One culprit, however, has gone unnoticed: A sweeping change in international rules governing the capital banks must hold. By requiring banks to boost the capital held in reserve against the loans carried on their books, the rules encouraged banks to get rid of those loans by turning them into securities to be sold to investors. Banks took the hint.

That’s complicating the Federal Reserve’s efforts to put out the current fire.

For more than 20 years, a club of central bankers has been tinkering with rules — known as Basel, for the Swiss city in which officials meet — to get banks to hold more capital so they can absorb major losses without threatening the financial system. Details are so technical that only insiders pay attention. Most of the time that’s just fine. The battles over the rules typically have had more to do with banks and countries jockeying for advantage than anything that mattered to borrowers in Boise or Bremen.

The rules are rooted in the worries of wise men like Paul Volcker, the former Fed chairman, that banks didn’t have enough capital, an especially acute concern after Germany’s Herstatt Bank defaulted on obligations to foreign banks in 1974 and the U.S. government rescue of big Continental Illinois National Bank & Trust in 1984.

The solution: A 1988 international accord required banks (in countries where national authorities adopted the rules) to hold more capital if they make riskier loans and investments. A bank that loans $100 million to other solid banks needs only $1.6 million in capital; a bank that loans $100 million to ordinary companies needs $8 million capital.

Banks are a special case. They’re traditionally at the center of the financial system; bank panics led Congress to create the Fed in 1913. And government insurance of bank deposits means most depositors needn’t worry if their banks make foolish loans. That can give bankers a heads-we-win/tails-you-lose incentive to gamble that regulators must monitor.

MORE

• Discuss: Is regulation partly responsible for the market mess?

The original Basel rules were crude, overwhelmed when banks figured out how to game them and were recently revised. The rules did succeed in getting banks to strengthen their financial footing. They did reduce the risks most banks take. Was that the intention? Yes. Is that always a good outcome? Well, maybe not.

Among other things, the rules required banks to hold more capital against an ordinary mortgage than against pools of mortgages turned into securities. So banks sold off individual mortgages and many replaced them with securities comprising pools of mortgages. Between 1988 and 1993, these mortgage-backed securities rose to more than 9% of bank assets from 2.9%.

This huge change in finance has advantages. Banks still make loans and hold them, but are more likely to originate and distribute loans. As a result, much of the risk of delinquencies on mortgages in inner-city Detroit isn’t shouldered by local banks but has been shifted to investors all over the world. (How many of these hot potatoes may actually return to bank balance sheets is a question for another column. Short answer: More than some bankers would like.)

It turns out, the folks who hold mortgage-backed securities are forced to be much quicker than banks are to acknowledge reality when the value of the collateral for loans drops. And banks now behave more like securities firms, more likely to mark down the value of assets when market prices fall — even to distressed levels — rather than sitting on bad loans for a decade and pretending they’ll be paid back.

It’s a huge contrast to the bad old days of the early 1980s when big New York banks found themselves holding lots of bad loans to Latin American governments and took years to write them down — or when Japanese banks’ reluctance to admit the size of their bad-loans problem paralyzed Japan’s economy.

But it may have some unwelcome effects: Banks aren’t the shock absorbers they once were at a moment of market panic. Because they hold fewer loans on their books, banks don’t have the ability to say, “These mortgages are more likely to be paid off than the market thinks today, and we’ll just hold on until the market comes to its senses.” Instead, the holders of mortgage-backed securities are dumping them, pushing down the price. This forces other leveraged players — those backed by borrowed money — to sell their holdings and, if not interrupted, an economically devastating downward spiral can take hold.

The Fed is now laboring to prevent such an outcome. But its tools are designed with banks in mind, not for a world in which banks have shifted risks to all sorts of other leveraged investors who are now forced to be obsessed with the value of their collateral.

The Fed, which was an enthusiastic proponent of these risk-based capital standards and securitization, is trying to prime the banking pump to put out the fire. Ironically, it’s discovering that’s harder because of unappreciated consequences of the Basel rules that were intended to make the banking system more fire-resistant.

Write to David Wessel at capital@wsj.com

http://online.wsj.com/article/SB118842768442912725.html?mod=economy_lead_story_lsc

Bank Demand Hits Record for ECB Loans

Market expectations continued to fall for an interest-rate increase by the ECB at its Sept. 6 meeting, as cash-starved euro-zone banks demanded a record amount of three-month funds.

Bank Demand Hits Record
For ECB’s 3-Month Loans

By JOELLEN PERRY and MONICA HOUSTON-WAESCH
August 30, 2007; Page A6

FRANKFURT — Cash-starved euro-zone banks demanded a record amount of regular three-month funds from the European Central Bank yesterday, as market expectations for an interest-rate increase at the Sept. 6 bank’s meeting continued to fall.

In its regular three-month financing operation, the ECB pledged €50 billion, or about $68 billion, as expected. But bids for the funds totaled nearly €120 billion, and the cutoff lending rate beat expectations to hit 4.56%. The cutoff rate for last week’s extra, one-time offer of €40 billion was 4.49%, and at the ECB’s last regular three-month operation, on July 25, the cutoff rate was 4.2%.

“Some banks were bidding quite high, because they were concerned they weren’t getting enough liquidity,” said Marco Kramer, an economist with UniCredit Global Research in Munich. Mr. Kramer noted that the rise in longer-term borrowing costs “is basically the same thing as if the ECB had [already] hiked rates.” Banks are likely to pass higher borrowing costs on to businesses and consumers seeking loans.

Rates on the funds that banks lend to each other overnight have fallen to around the ECB’s 4% target since the bank injected massive amounts of short-term cash into the banking system earlier this month in response to a sharp tightening in credit markets. But three-month rates remain high, suggesting banks remain reluctant to lend to each other over longer periods.

Markets, which have been on a roller coaster since the ECB started pumping billions into money markets Aug. 9, now think there is only a small chance that the central bank will announce a quarter-point increase in its refinancing rate, to 4.25%, at next week’s meeting.

On Tuesday, ECB Executive Board member Lorenzo Bini Smaghi said markets had “perfectly understood” the bank’s president, Jean-Claude Trichet, who re-emphasized Monday that the bank isn’t “precommitted” to a rate rise. Mr. Trichet made clear that the bank, in a departure from its typical method of signaling rate decisions well in advance, is keeping its options open.

Many economists now maintain that the bank will remain on hold next week, to avoid further rattling jittery markets and to assess the economic impact of the financial turbulence.

But others contend that a still-robust economy and continuing inflation threats will push the bank to an increase next week. European Union officials yesterday said the turbulence hadn’t yet damaged the euro-zone’s growth prospects.

–Emese Bartha contributed to this article.

Write to Joellen Perry at joellen.perry@wsj.com and Monica Houston-Waesch at nikki.houston@dowjones.com

Hedge Funds Do About 30%
Of Bond Trading, Study Says

By CRAIG KARMIN
August 30, 2007; Page C3

There was a time when debt was considered a boring investment, held primarily by institutions seeking predictable returns or a steady stream of interest payments. A recent study by the consulting firm Greenwich Associates shows how much that’s changed.

Hedge funds have quickly become a dominant player in the world of debt. In some corners of the market — often among the most complex areas — they are the biggest force by far. Hedge funds are responsible for nearly 30% of all U.S. fixed-income trading, according to the survey.

DOMINATORS

• The News: A study shows how important that hedge funds have become in debt trading — they do nearly 30% of U.S. bond volume.

• Doubled Up: The amount of trading doubled in just a year, the study by Greenwich Associates showed.

• Impact on Investors: This isn’t your father’s debt. Hedge funds often focus on short-term goals, not the long-term holdings that other investors may prefer.

That level, which reflected activity over a 12-month period through April, was double the amount of trading hedge funds accounted for the previous year. Greenwich found hedge-fund trading comprises 55% of U.S. activity in derivatives with investment-grade ratings, and also 55% of the trading volume for emerging-market bonds.

The rapid rise in hedge-fund trading underscores the changing nature of the debt markets. Unlike many mutual funds that look for stable returns or pensions and insurers that want steady, long-term holdings, hedge funds frequently seek short-term gains through numerous trades they can amplify with borrowed money.

“We’ve seen over the past 10 years a proliferation of products created to meet the needs of hedge funds,” says Tim Sangston, a managing director at Greenwich Associates. “More and more of the growth in bond trading is coming from these kind of professional traders and investors.”

In some corners of the U.S. debt market, hedge funds practically are the market. For instance, hedge funds generated more than 80% of the trading for derivatives with high-yield ratings, and more than 85% of volume in distressed debt, Greenwich found.

Hedge funds also accounted for a good portion of the trading in mortgage-backed securities, asset-backed securities, collateralized debt obligations and other parts of the debt market that have suffered recently as worries over subprime loans have spread.

Analysts say these debt instruments were developed primarily for sophisticated investors like hedge funds, which sometimes use these products to protect themselves. But the debt securities have also been peddled to pension funds and other institutions that may not completely understand them.

The survey involved responses from 1,333 institutions in North America, including mutual funds, insurance companies, pension funds, banks, brokerage firms’ proprietary trading desks and federal agencies, Greenwich said. These investors were polled about their trading in 15 kinds of debt instruments. Overall, debt-market trading volume among the participants increased by 10% in the period, to $25 trillion, from the previous year.

Write to Craig Karmin at craig.karmin@wsj.com

/////////////////////////////

Hedge Funds Double Share of Fixed-Income Trades (Update1)
By Jenny Strasburg

Aug. 30 (Bloomberg) — Hedge funds doubled their share of U.S. fixed-income trading to 30 percent and dominated the market for some securities as debt-market volatility increased, according to a study by Greenwich Associates.

“The recent expansion of hedge-fund positions and trading activity has been so rapid and consistent that it is now no exaggeration to say that hedge funds are no longer just an important part of the market in some fixed-income products; they are the market,” according to the report, which covered the 12 months ended in April.

Hedge funds accounted for more than 80 percent of trading in the debt of financially distressed companies and high-yield derivatives such as credit-default swaps, the Greenwich, Connecticut-based consulting and research firm said. The loosely regulated investment pools generated almost half of U.S. trading volume in structured credit.

Hedge-fund assets worldwide increased almost threefold in the past five years to $1.75 trillion as of June, according to Chicago-based Hedge Fund Research Inc. Fund managers’ appetite for fixed-income assets has fueled growth in trading volume as well as concerns about who might buy the debt products in troubled markets.

Trading by all institutions in distressed debt more than doubled to $42 billion in the 12-month period, according to the report. Leveraged-loan trading doubled to $241 billion. Total debt-trading volume increased 10 percent to $25 trillion.

Hedge funds “appear more concerned than other U.S. fixed- income investors about liquidity risk,” according to the study, referring to worries buyers might disappear when trading becomes volatile. By comparison, other investors cited risk of default as their top worry.

Market Casualties

Bear Stearns Cos. last month sought bankruptcy protection for two hedge funds that invested in securities backed by home loans to the riskiest borrowers. The New York-based investment firm closed the funds after granting $1.6 billion in emergency financing in June and then telling investors they would get little, if any, money back.

Credit pools managed by UBS AG’s former hedge-fund affiliate Dillon Read Capital Management LLC and Sowood Capital Management LP of Boston also failed this year after the value of their holdings declined and clients sought refunds.

`Take Careful Note’

Hedge funds’ share of structured-credit trades shows that the funds “have become the biggest force” in markets for many debt instruments that are often are the most complex to price and trade, Frank Feenstra, a Greenwich Associates managing director, said in the report. “With all of the current issues surrounding subprime-mortgage debt and collateralized-debt obligations, investors should take careful note of this finding.”

About 25 percent of the trading in U.S. asset-backed securities was done by hedge funds. They were responsible for 20 percent of the volume in mortgage-backed securities trading.

Among hedge funds interviewed for the study in both 2006 and 2007, fixed-income trading volume increased about 90 percent, Greenwich Associates managing director Tim Sangston, a former fixed-income associate with Goldman Sachs Group Inc., said in the report.

Greenwich Associates based its report on interviews conducted between February and April with 1,333 mutual funds, pension funds, banks and other institutions.

Holders of fixed-income securities in general traded the instruments more frequently in the past year than previously, Greenwich Associates said. The research firm based that conclusion on data showing trading volume outpacing the rise in debt assets under management.

Comparing Returns

Institutional investors, including corporate and public pension-fund managers and endowments, expected an average return of 5.2 percent from fixed-income assets over the five years starting in 2006, the firm said. Expectations for equities were 8.3 percent; 8.8 percent from hedge funds; and 11.7 percent from private-equity funds.

Hedge fund manager can buy or sell any assets and participate substantially in profits from money invested. Private-equity firms acquire part or all of a company using debt to finance typically about two-thirds of the purchase price. They usually hold investments for three years or more while they seek to increase profits, then try to sell to other companies or investors through an initial public offering.

To contact the reporter on this story: Jenny Strasburg in New York at jstrasburg@bloomberg.net .

Last Updated: August 30, 2007 16:02 EDT

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BERNANKE IS SHOWING signs of a break with Greenspan by distinguishing between the Fed’s two main roles of maintaining financial and economic stability.  12:20 a.m.

• Video: Greg Ip on what the break suggests

• Vote: Is Bernanke more effective than Greenspan?

Bernanke Breaks Greenspan Mold

Managing Crisis, Fed Chief
Dulls Notion That Turmoil
In Market Leads to Rate Cut

By GREG IP

WSJ
August 30, 2007; Page A3

WASHINGTON — When Ben Bernanke was nominated to head the Federal Reserve in 2005, he promised to “maintain continuity with the policies and policy strategies established during the Greenspan years.” But in handling his first financial crisis, Mr. Bernanke shows signs of a break with Alan Greenspan, the Fed’s chairman from 1987 to 2006.

That shift is important in understanding why Mr. Bernanke hasn’t cut the Fed’s main interest rate yet, and it could alter investors’ expectations of how the Bernanke Fed will function.

The Fed historically has had two major economic duties. Maintaining financial stability is one. Controlling inflation while preventing recession is the other.

To Mr. Greenspan, market confidence and the economy’s growth prospects were so intertwined as to make the Fed’s two duties almost inseparable. He cut rates after the 1987 stock-market crash and the near-collapse of hedge fund Long-Term Capital Management in 1998 to prevent investor reluctance to take risks from undermining the nation’s economic growth.

By contrast, Mr. Bernanke distinguishes between the central bank’s two functions. So, on Aug. 17, the Fed cut the interest rate and lengthened the term on loans to banks from its little-used discount window in hopes banks would use the window — or at least the knowledge it was available — to lend to solid borrowers having trouble getting credit amidst the market turmoil. The action was aimed at restoring the normal functioning of disrupted credit markets, not primarily at boosting growth.

The Fed, meanwhile, hasn’t cut the far more economically important federal-funds rate, charged on loans between banks, which is the benchmark for all short-term U.S. borrowing costs.

To be sure, all central bankers see a link between financial and economic stability. Falling prices for assets like stocks, bonds and homes and tighter credit conditions can damp spending and investment.

But, “There’s no doubt they were trying to draw a distinction between using the main tool of monetary policy, which is the federal-funds rate, and aiming the discount rate at restoring the plumbing,” says Alan Blinder, a former Fed vice chairman.

To be sure, if Mr. Bernanke eventually cuts the federal-funds rate, as markets anticipate, the contrast with Mr. Greenspan will be less sharp. Mr. Bernanke will elaborate on the outlook tomorrow at the Federal Reserve Bank of Kansas City’s annual symposium in Jackson Hole, Wyo.

Yesterday, Sen. Charles Schumer, a New York Democrat, released a letter from Mr. Bernanke dated Monday that repeated the Fed’s Aug. 17 pledge to “act as needed” to help the economy. Though there was nothing new in the pledge, traders said it contributed to the Dow Jones Industrial Average rising 1.9% to 13289.29. (See article.)

Mr. Bernanke’s approach to the credit crunch is, in part, an effort to undo perceptions fostered by Mr. Greenspan’s rate-cutting interventions. Though successful, they drew allegations of “moral hazard” — that is, of encouraging investors to act more recklessly because they think the Fed will protect them.

Neither Mr. Bernanke nor his closest colleagues, some of whom served under Mr. Greenspan, believe there ever was a “Greenspan put,” a reference to a contract that protects an investor from loss.

Yet officials acknowledge the perception that the Fed has bailed out investors in the past. When the stock market crashed in 1987, Mr. Greenspan, then on the job for just two months, used aggressive open-market operations — buying and selling government securities — to pump banks full of cash, which caused the federal-funds rate to fall to about 6.75% from 7.25%. His priority was to keep banks well supplied with cash so that strapped securities dealers wouldn’t fail for lack of financing.

“We shouldn’t really focus on longer-term policy questions until we get beyond this immediate period of chaos,” transcripts record him telling colleagues the day after the crash. The Fed kept the funds rate low in ensuing months, and the economy didn’t skip a beat.

In 1998, Russia’s default on its debt, followed by the near-collapse of Long-Term Capital Management, caused credit markets to freeze up, much as they have recently. Mr. Greenspan’s reaction illustrated how much he considered investors’ attitudes toward risk as intrinsic to the economy’s health.

“It would be wrong to say that the change in psychology is all ephemeral just because we have not seen it in the hard data yet,” he told colleagues. “It is the change in value judgments that alters the real world.” The Fed cut interest rates three times by a total of three-quarters of a percentage point that fall. The economy accelerated, and the stock market, erasing its losses, went on to more spectacular gains.

Al Broaddus, research director and later president of the Federal Reserve Bank of Richmond during Mr. Greenspan’s tenure, says Mr. Greenspan’s response in 1987 was right. “A 20% drop in the stock market was a clear threat to economic conditions.” But he says that in 1998, he and some others were skeptical of the need for such drastic action to deal with market instability. “If we could have argued for something like Bernanke is doing this time as opposed to three funds-rate reductions, we might have done that.”

Mr. Bernanke may yet have to cut rates. But the longer he waits, the more likely he can break investors of the assumption that market convulsions lead to interest-rate cuts. There is evidence he is succeeding. On Aug. 16, with stocks plunging and debt markets in disarray, money manager Bridgewater Associates wrote in its widely read daily commentary: “Credit in the economy is shutting down, and the Fed needs to ease now.”

By this past Tuesday, with markets having settled down, the same firm wrote: “If we were in the Fed’s shoes, we certainly wouldn’t be in a hurry to ’save the system’ until there was more evidence that the system needed saving.”

Write to Greg Ip at greg.ip@wsj.com

Wall Street All Ears for Fed Chief’s Big Speech
Washington Post - 3 hours ago
By Neil Irwin Tomorrow, Ben S. Bernanke will deliver the most important speech in his 19 months as the world’s most powerful central banker.
The Worst of All Policies - Federal Reserve Policy Blunders The Market Oracle
Wall St rallies after Bernanke pledge Financial Times
Canada.com - Wall Street Journal - Melbourne Herald Sun - Forbes
all 66 news articles »

“Instead of talking about the contemporary flashpoint, it will be a scholarly disquisition,” said Alan S. Blinder, a Princeton University economist and former Fed vice chairman. “I don’t expect to hear out of his mouth the words BNP Paribas, Countrywide, Bear Stearns, or any of that,” he said, referring to companies that have been central to the recent market fluctuations.

“He doesn’t want to rock a lot of boats,” Blinder said. “One objective is not to make news.”

Bernanke Opposes Lift Of Fannie, Freddie Caps

David S. Hilzenrath, D04 (Post)

08/30/2007

Article

Federal Reserve Chairman Ben S. Bernanke said Fannie Mae and Freddie Mac don’t need a loosening of regulatory constraints to help borrowers threatened with foreclosure…

Wall Street All Ears for Fed Chief’s Big Speech

Remarks to Be First Since Credit Crunch

Washington Post Staff Writer
Thursday, August 30, 2007; Page D01

Tomorrow, Ben S. Bernanke will deliver the most important speech in his 19 months as the world’s most powerful central banker.

In his first public comments since financial markets unraveled this month, the Federal Reserve chairman faces risks on all sides. If he seems indifferent to turmoil on Wall Street, markets could go haywire all over again. If he seems too eager to take actions to help the markets, it might encourage investors to behave irresponsibly in the future.

What he is likely to do, close watchers of Bernanke and the Fed said, is lay out his view that it is important to distinguish between prices of securities dropping and a breakdown in the markets. As Bernanke has explained in past speeches and writings, the Fed need not take action just because the prices of, say, complicated securities backed by mortgage debt have plummeted.

But the Fed does need to worry, in his view, when there is sustained panic and markets freeze up, as they did in early August, such that investors will not buy corporate debt or other assets at any price. The fear is that a credit crisis makes it difficult for sound businesses to invest or consumers to engage in day-to-day transactions.

“The chief characteristic of a financial panic is that investors lose their bearing,” said Lyle Gramley, a former Fed governor who is now senior economic adviser to Stanford Washington Research Group. “They’ve become frightened. They don’t know what to think about where things are going.”

Wall Street will be scrutinizing every word for hints about whether the Fed will cut a key interest rate — and if so, how much — at a meeting of its policymaking committee Sept. 18. Trillions of dollars in trades hang on every comma. But Bernanke’s past practice has been to deal with such questions obliquely, and Fed watchers say he is highly unlikely to lay out specific new policy steps for the central bank.

The Fed’s next big move depends heavily on what happens in financial markets and the economy from now to its Sept. 18 meeting. And interpreting that information will be tricky.

The Federal Open Market Committee, which sets the central bank’s policy on interest rates, typically relies heavily on a sophisticated computer model that projects where the U.S. economy is heading. Several committee members have customized versions of the model, which they use to develop their personal projections.

But such models are not terribly useful in times of financial crisis, economists say. Most of the data are weeks or months old, and in moments of turmoil, the economy tends to shift in unpredictable ways.

Fed policymakers will also be listening carefully to the presidents of the 12 regional Federal Reserve banks around the country. Each president is in frequent contact with business leaders in his or her region.

If the regional bank presidents report that their business contacts view the problems in credit markets to be confined to Wall Street, the Fed will feel little pressure to act. If, on the other hand, they report that their access to capital has been choked off or that consumer spending is slowing, that would weigh heavily as a reason for the Fed to cut the federal funds rate or take other aggressive action.

To the degree that they can use economic data to decide about a rate cut, Fed policymakers might look closely to more arcane data than that which normally shapes their decision-making.

Companies tend to be slow to lay off employees when hard times hit, but they are quicker to cease hiring. Similarly, workers are disinclined to quit when there are few openings elsewhere. So in the early phases of a downturn, job growth remains steady and the unemployment rate does not change, even as fewer people are switching jobs.

That shows up in the Labor Department’s job openings and labor-turnover report, published each month. If the July report, to be released Sept. 11, shows that the nation’s job market was starting to freeze up, it could be a sign of trouble.

Each Thursday, the Labor Department reports how many workers filed for initial unemployment benefits in the previous weeks, an early but volatile sign of widespread job cuts. There were 322,000 such claims last week, a number that does not raise alarm bells among economists.

Consumer confidence and other survey data show how market problems are affecting peoples’ views. On Tuesday, the Conference Board said its consumer confidence measure fell to the lowest level in two years.

“What the Fed does is very scenario-driven,” said Peter Hooper, chief economist of Deutsche Bank Securities who previously was on the Fed staff. “A September rate cut would be driven by a feeling that confidence has really taken a hit.”

But that measure can plummet without necessarily meaning the economy is on the rocks, as was the case following Hurricane Katrina.

Fed policymakers are not particularly interested in the exact level of the Dow Jones industrial average or the interest rate for a jumbo mortgage. Rather, they focus on whether transaction volume in troubled credit markets is increasing. They would like the difference between what buyers of assets are willing to pay and what sellers will accept, known as the “bid-ask spread,” to narrow.

Assuming he follows his past practice, Bernanke, in his speech, is expected to take an academic approach, as befits a man who was a college professor for 23 years. He is likely explain the intellectual prism through which he is inclined to make decisions in the months ahead, not what those decisions will be.

“Instead of talking about the contemporary flashpoint, it will be a scholarly disquisition,” said Alan S. Blinder, a Princeton University economist and former Fed vice chairman. “I don’t expect to hear out of his mouth the words BNP Paribas, Countrywide, Bear Stearns, or any of that,” he said, referring to companies that have been central to the recent market fluctuations.

“He doesn’t want to rock a lot of boats,” Blinder said. “One objective is not to make news.”

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